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MIA Journal: Who bears the taxes in the digital arena?

Repost of journal publication on Malaysian Institute of Accountants on 17 June 2019.
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, 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 in 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.

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 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 RMCD is concerned, most of the services procured through the internet is subject to service tax and this leaves the taxpayer with limited option: 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 the route 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.


Who bears the burden of tax?
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 IRBM. The withholding tax in question here will be principally be withholding tax imposed on royalties.

Royalty definition 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 are the following paragraphs:

- 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.