During the recent midterm review of the 11th Malaysia Plan, the government sent its clearest signal yet that it plans to introduce a new tax on “online transactions”. Now consumers and businesses alike eagerly await more details on what exactly this new tax will look like and how much it will cost them.
The upcoming Budget 2019 might provide more details. But what are the options for imposing a new tax on the digital economy? What could the impact be? The first thing to recognize is that Malaysia is not alone in considering this question. Around the world, countries are looking at different options to impose new digital taxes. Often, the argument goes that digital companies don’t pay enough tax, but is this really true? Not according to research by the European Centre for International Political Economy, which found that contrary to popular opinion, global effective tax rates for digital companies were the same as-if not higher than -traditional companies.
At a roundtable on digital tax hosted by the Institute for Democracy and Economic Affairs (IDEAS) last month, the general consensus in the room was that how much tax is being paid is no longer the issue.Instead, in Europe and elsewhere, politicians are now arguing that digital companies should pay tax in the countries where the products are consumed, not just where they are made.
They argue that digital services, like social media, fundamentally depend on the participation of users and therefore should pay tax in the jurisdiction where their users are based. There is a disagreement on this issue globally, but perhaps the more important point is that this isn’t so much a disagreement between countries and the industry over how much tax is paid, but rather a disagreement between countries who the tax is paid to. In other words, how to allocate tax from the digital economy between countries.
This means that the only resolution can come from agreement between countries, which is why the Organisation for Economic Cooperation and Development has put together-a task force to consider the issues and submit a report in 2020.
But some countries are not prepared to wait for that and are pressing ahead with their own unilateral measures. Or trying to at least.
Given the legal murkiness of claiming additional taxes on this basis, these new taxes could be quickly challenged for creating instances of double taxation -where the same profits are taxed twice. If Malaysia chooses to go down the path of imposing a unilateral direct tax on foreign digital companies, other countries might do the same.
This would introduce new costs for Malaysia’s exporters and act as a brake on digital trade. At the end of the day, Malaysia has a relatively small domestic market and thrives when it is open to trade and investment, and when Malaysian companies can go out in the world to compete. A digital tax risks that openness.
A less controversial choice would be to expand the scope of indirect taxes to cover digital goods and services from abroad.
This approach-to tax the consumption, not the profits -is consistent with existing tax principles and is the approach being taken by many countries worldwide, including Singapore. Implementation is tricky though, with Malaysia only recently having reverted back to the Sales and Services Tax (SST); reforming it to cover foreign digital companies would add significantly to the Royal Malaysian Customs Department’s to-do list.
Still, it would certainly be easier than trying to develop a whole new tax which could fall at the first hurdle.
But what about the impact of these taxes? How would they shape the development of the digital economy in Malaysia? First off, the price of digital goods and services would likely increase. This would impact the price of digital goods and services for consumers -subscriptions to services like Spotify and Netflix, as well as one-off purchases on e-commerce platforms.
It would also drive up prices for businesses in Malaysia, particularly small businesses and start-ups that use online platforms, such as cloud computing or social media, both for advertising and sales.
Naturally, this would be expected to slow growth in the digital economy. One advantage with expanding SST to cover foreign supplied digital goods and services is that it would level the playing field with domestic providers who are already subject to SST. It would also send a less negative signal on digital trade than a new direct tax as it represents a less radical option. It would, however, still increase the costs for consumers and businesses in Malaysia in all the ways spelled out above.
As one start-up put it at the round-table, in many cases there are no local alternative providers for the services they need, so a new tax wouldn’t change their behaviour, but just increase their costs.
So, since there are no easy options, it then becomes a question of priority -yes, the government needs revenue, but is the digital economy the place to get it? Few believe that there is no waste in Malaysia’s public spending; already the new government has been able to slash the cost of procurement deals and there are certain to be more savings that can be achieved.
Shouldn’t that be addressed first before we start introducing new costs for start-ups and exporters? But assuming the government does decide to press ahead with a new tax, it is important to get it right.
The signs are that the government will go with the less problematic option of expanding the scope of SST, which is encouraging news. But whatever direction the government takes, consultation with the industry will be crucial to ensure that design and implementation is as smooth as possible. Hopefully, the government will provide further clarity on their plans soon.
First published in The Malaysian Reserve, 30th October 2018.