Malaysia will extend its service tax to imported online services, including music and video streaming, in 2020 in a bid to offset advantages that foreign digital companies have over the country’s brick-and-mortar businesses.
In his first budget speech to Parliament, Finance Minister Lim Guan Eng on November 2 gave an update on the country’s return to a sales and service tax (SST) regime following the election of the new government under Prime Minister Mahathir Mohamad in May.
Under the SST regime, which replaced the goods and services tax system September 1, only 100,000 companies are currently required to collect the SST, versus 472,000 companies that had to collect GST, a sign that the move has greatly lightened small and medium-size enterprises’ compliance burdens, Lim said.
The government plans to improve the effectiveness of the SST by granting exemptions starting January 1, 2019, for specific business-to-business service tax for companies registered under the regime, which will help protect Malaysia’s local service industry, Lim added.
The finance minister noted that a tax reform committee set up in September to evaluate other improvements to the tax system recommended measures to ensure that Malaysian companies aren’t at a competitive disadvantage to foreign competitors.
The SST will apply to online services imported by Malaysian businesses, which will be required to collect and pay the tax starting January 1, 2019. However, for online services imported by consumers, foreign service providers will have to register with Royal Malaysian Customs and collect and remit the SST on those transactions, starting January 1, 2020, according to Lim. Services covered include, but aren’t limited to, software, video, music, and digital advertising, he added.
Those measures “will neutralize the cost disadvantage faced by physical retailers against their virtual storefront counterparts, especially those operated by foreign entities,” Lim said. Under the SST regime, goods are taxed at either 5 percent or 10 percent, and services are taxed at 6 percent.
The government has yet to announce the mechanism by which foreign companies can register to collect and remit the tax, Mui Lee Leow, managing director of Axcelasia Taxand Sdn Bhd, told Tax Notes. “What is clear is that such companies providing digital products or services would be required to charge service tax and to submit service tax returns when the law is effective,” she added.
Lim’s proposal is in line with tax policy in neighboring Singapore, which announced in February that it would extend its GST to imported services, including apps and music downloads, starting January 1, 2020.
Malaysia’s announcement also comes after some media speculation about what kind of action it would take to address the tax challenges of the digital economy, following the United Kingdom’s October 29 proposal for a 2 percent digital services tax (DST) on social media platforms, search engines, and online marketplaces that generate U.K. revenues linked to U.K. user participation.
The U.K. proposal, which is similar to a controversial EU DST plan, prompted the United States to threaten action if countries take unilateral action to tax predominantly American digital giants. The United States also pushed for countries to continue participating in international talks led by the OECD to find consensus on a long-term solution to taxing the digital economy by 2020.
Most recently, the World Bank urged the Malaysian government to raise much-needed tax revenue by taxing the digital economy, pointing to options like a free-standing tax on foreign suppliers of digital services, similar to the proposed EU DST.
However, Malaysia’s announcement is in line with the OECD’s recommendation that any tax levied on the digital economy should be a consumption tax, according to Yvonne Beh, a partner in the tax, trade, and wealth management practice of Wong & Partners, a member firm of Baker McKenzie International.
The revised OECD international VAT/GST guidelines, published April 2017, endorse the destination principle when allocating taxing rights, meaning that goods and services should be taxed in the jurisdiction in which they are consumed. The previous Malaysian government had also indicated that it would amend its GST regime to comply with the guidelines.
Beh welcomed the fact that Malaysia’s new government did not introduce any unilateral direct measures and said the proposal’s 2020 start date would allow foreign service providers ample time to comply with the new rules.
“We understand that the Malaysian Ministry of Finance was considering the options available to tax the digital economy, including unilateral measures and taxing from an indirect tax perspective,” Beh told Tax Notes. However, there hasn’t been any indication from the MOF that it is considering unilateral measures to tax digitalization.
“With the current proposal to impose service tax on the supply of digital services to consumers, this is a good move in the right direction in terms of adhering to the OECD’s recommendation on the taxation of digital transactions,” Beh said.