This article was published in Focus Malaysia on 30th March 2019.
Knowingly or unknowingly, the tax policymakers have walked into a situation which has ended up burdening Malaysian taxpayers. This is because large foreign IT service providers are not willing to pay the Malaysian tax, thereby transferring the burden of tax to their Malaysian partners. Such payments to them, in most cases, are a withholding tax of 8% to 10% and a service tax of 6%.
Has the tax policy achieved its objective?
The current tax policy of trying to tax the foreigners has not achieved its objective but instead has ended up passing the burden of taxation to Malaysian businesses. To make matters worse, these payments are subject to double taxation and give rise to interpretational problems.
Do you need the foreign IT service providers?
In the current business environment, for any vibrant business planning to grow, it inevitably requires IT services from foreign companies such as Facebook, Amazon Web Services, LinkedIn, Google, Microsoft and other IT service providers relevant to each industry. There is no choice but to buy these services and “silently” suffer the pain of bearing the taxes that were intended to be imposed on foreigners.
The double taxation dilemma
Withholding tax: The income tax issue is simple: Are the payments for services rendered from overseas by non-residents treated as payments for services or are they royalty payments? If the services purchased are regarded as services rendered by non-residents from overseas, then the withholding tax will not be applicable. However, royalty payments are subject to withholding tax. In summary, the royalty issue here is whether the payment is for the “use of, or the right to use copyrights., software., secret processes or formula., or other like property or rights.” The full definition is in Section 2 of the Income Tax Act, 1967.
The Inland Revenue Board (IRB) in practice takes a very broad approach and is generally of the view that most payments made to foreign IT service providers fall under the definition of royalty payments. This can include digital advertising, subscription to information databases, software licences, subscription to online journals and newspapers. On this matter, there is practically very little guidance from the IRB other than principally a Practice Note issued on March 16, 2018.
There are many tax professionals who do not agree with the interpretation of the IRB. Other countries such as Singapore have lessened the burden on businesses by providing clarity and differentiated payments for using and exploiting copyrights to further one’s business (royalty payments) vs the payments for a copyrighted article. The closest analogy would be paying for the purchase of a book where the copyrights are retained by the author. Withholding tax is not applicable in this instance. Australia is another example where clarification has been provided by the authorities. For the moment, most taxpayers are silently suffering the pain and bearing the withholding tax, the reason being it is too expensive to go to court and they do not wish to debate these matters in court if the amounts are insignificant. More importantly, businesses need certainty and paying the tax avoids confrontation and provides closure.
Service tax: Service tax of 6% is imposed on all taxable imported IT services. IT services have been defined in the Royal Malaysian Customs Department (RMCD) guide to include:
The coverage is extremely wide and appears to cover all IT services. There are interpretational issues on whether certain payments would fall within the provision of services. Talking to the RMCD inevitably ends up with the taxpayer paying taxes. Again, taxpayers end up bearing this tax too.
Where is the fairness?
To an ordinary man, it appears to be unfair. It is about time to look at whether such payments should be subject to both income tax and service tax. This is a policy matter that should be decided by the government: Do you want to reduce the cost of doing business or stick to the law and apply double taxation? A pragmatic business decision which will help businesses grow will be the wise one.
If the intention is to bring such payments under service tax, then taxpayers should be relieved of the burden of paying withholding tax or vice versa. More guidance and clarity are needed from the authorities on these matters and they need to be more willing to discuss with taxpayers on this matter. Since the interpretational issues are complex, it would be advisable if questions relating to these matters are addressed to a specific group of people within the IRB or the RMCD rather than taxpayers receiving different answers from different officers of both agencies. Confusion must be avoided and clarity should be established.