Digital Tax- An Overview
27 February 2020
Recently, in anticipation of Malaysia’s transition to a digital economy, the imposition of 6% service tax on foreign digital services (“Digital Tax”) came into force on 1 January 2020 pursuant to the Service Tax (Amendment) Act 2019. With the inception of this Digital Tax, foreign service providers (“FSPs”) are now required to account and pay a service tax of 6% on any digital services provided by an FSP to consumers in Malaysia, including services provided by businesses to consumers.
Implementation of Digital Tax would help plug the fiscal loophole which has caused Malaysia to forego substantial fiscal revenue from foreign digital services. Take advertising for instance, based on reports, whilst Malaysia’s overall advertising expenditure market grew from 2015’s 17.9% to 35.4% in 2019, approximately 80% share went to Facebook and Google1 (with approximately RM 1.5 billion to RM 2.0 billion of advertising income paid by Malaysian advertisers to Facebook and Google’s overseas headquarters or subsidiaries),2 and even less taxes were are paid by these companies on the income earned from Malaysians.3
This outflow is not peculiar to Malaysia; within the European e-commerce sphere, EU member states lost up to approximatively €3.8 billion annually in missing VAT on business to consumers cross border supplies of goods.4 This is largely due to a growing number of digital businesses having an economic presence in a jurisdiction but limited physical presence, consequentially disrupting the way companies do business. To put the potential outflow into perspective, globally, digital marketplaces are expected to account for US$ 995 billion to $5.1 trillion of annual transactions by 2020, of which cross-border transactions will comprise around 20 percent.9
The implementation of Digital Tax in Malaysia came at a time where the imposition and stance of digital service tax globally is in a state of flux. Notwithstanding ongoing talks at the Organisation for Economic Co-operation and Development (“OECD”) level, many countries who were raring to get a palatable share of tax revenue have went ahead and imposed digital taxes at a national level, e.g.: India, South Korea, Japan, France.
In the meantime, the United States (US), who is home to many tech giants, is ostensibly the sole country who is aggressively opposing and protesting the imposition of digital taxes in other nations, including France, United Kingdom (UK), Italy5 and Czech Republic6 and even against OECD’s proposals. A pointed example would be the public spat between US and France, wherein the Trump administration has threatened to impose sanctions by way of tariffs on French imports in retaliation to France’s imposition of a 3% digital tax on tech companies servicing French consumers, dubbed GAFA tax for its targeted impact on American tech companies Google, Amazon, Facebook and Apple. At the time of writing, the US and France has just struck a temporary truce to suspend the collection of French digital tax as well as threatened US tariffs respectively until end of 2020 when a consensus is agreed at the OECD level. 7
Whilst France has agreed to a temporary suspension of its national tax regimes, at the time of writing, UK and Italy are seen determined to bulldoze forward with their respective national digital tax laws notwithstanding US’s consistent threats of tariffs to deter other jurisdictions from encroaching on what it sees as its taxing rights. 8
Section 2 of the Service Tax Act 2018 (“the Act”) provides for the following salient definitions:
- “Foreign registered person” (“FRP”), means any foreign service provider who is registered under section 56C of the Act.
- “Foreign service provider”, or FSP, means any person outside Malaysia providing any digital service to a consumer. This includes any person outside Malaysia operating an online platform for buying and selling goods or providing services (whether or not such person provides any digital service) and who makes transactions for provision of digital services on behalf of any person.
- “Consumer” means any person who fulfils any two of the following:
- makes payment for digital services using credit or debit facility provided by any financial institution or company in Malaysia;
- acquires digital services using an internet protocol address registered in Malaysia or an international mobile phone country code assigned to Malaysia;
- resides in Malaysia.
- “Digital service”, on the other hand, is broadly defined under the Act as any service that is delivered or subscribed over the internet or other electronic network and which cannot be obtained without the use of information technology and where the delivery of the service is essentially automated.
Digital Tax Registration Threshold
Under the Act, FSPs who provide digital services to consumer are liable to be registered as FRP should the total value of digital services provided to Malaysian consumers exceeds RM500,000 per year. The liability to register can be determined using two different methods, the ‘historical method’ or the ‘future method’, i.e.: if at the end of any month, the total value of all digital services exceeds RM 500,000 in the preceding 12 months (including month in question) or if there are reasonable grounds for believing that the total value of all digital services provided will exceed RM500,000 in the following 12 months (including month in question), which may be expected if a FSP have signed a written contract/agreement to provide digital services or received confirmed purchase orders from customers.
Other Requirements under the Act
FRPs are also subject to the following duties and requirements under the Act, including:
charging Digital Tax for provision of digital services provided to consumers;
issuing invoice or document containing prescribed particulars to consumers;
paying to the Director General the Digital Tax due and payable when FSPs receive payment for the digital services rendered in time and file returns within the prescribed period;
keeping complete and true records written up to date of all transactions which affect or may affect their tax liability for seven years. Under the Guide on Digital Services published by the Royal Malaysian Customs Department (“Guide”), so long as the records are readily accessible when required, FRPs may keep their documents or records relating to the Digital Tax outside Malaysia.
Malaysia has settled on a broad statutory definition on the taxation of digital services. Thus, where helpful, reference is made to the sources such as the Guide as well as OECD discourse surrounding the taxation of digital services.
The term “consumer” is defined in the Act in a manner wide enough to include businesses. Prior to the introduction of Digital Tax, services which are imported taxable services, i.e.: “ “any taxable service acquired by any person in Malaysia from any person who is outside Malaysia.. ” are required to account for 6% service tax. This has the effect of requiring local service providers who acquired taxable service from persons outside Malaysia to account for 6% service tax.
To alleviate concerns of double taxation since the introduction of Digital Tax, the Ministry of Finance (“MOF”) has also announced several measures to eliminate double taxation: 9
Firstly, group relief facilities will be extended to eligible imported taxable services by local service providers should they belong to the same group of companies providing the same imported taxable services. With so, if local service providers import services from overseas service providers in same group, the former need not be taxed on taxable services imported from overseas service providers in the same group;
Where the imported taxable services imported by local service provider from overseas service provider is the same as that provided by FSP in Malaysia, the local service provider will be exempted from accounting and payment service tax on importing professional and advertising services; and
Local service providers who paid the service tax to foreign service providers for digital services for business-to-consumer (B2C) transactions can claim a refund from the Royal Malaysian Customs Department, with an offset based on the actual amount of service tax paid.
The Act defines “digital service” as any service that is delivered or subscribed over the internet or other electronic network and which cannot be obtained without the use of information technology and where the delivery of the service is essentially automated. Under the Guide, it further is stated that “[d]igital services means services that is to be delivered through information technology medium with minimal or no human intervention from service provider.”10 Further guidance is gleaned from OECD literature, as even though Malaysia is not a member of the OECD, Malaysia is an Associate participant vis-à-vis the Inclusive Framework on Base Erosion Profit Shifting (BEPS) Project.
The OECD Working Papers describe “automation” as “the application of machines to tasks once performed by human beings or, increasingly, to tasks that would otherwise be impossible. In the context of electronic networks when a supply is essentially automated it means that the process, technique or system via which it is being delivered is automated through the use of computers and computer software (electronic devices). Such a process requires less human intervention and less human time to deliver.”11
Also, it is noted that minimal human intervention refers to the relationship between the supplier and his customer12 and the activity of a third party, to which services may in one way or the other relate is not relevant for the purposes of assessing “minimal human intervention” of the supply of those services. 13
Instructive examples of “digital service” given in the Guide include online licensing of software, provision of mobile applications, provision of music, live streaming services, subscription-based media content, online advertising space on intangible platforms, online trading platforms, search engines and social networks, databases, website hosting, online data warehousing, file-sharing and cloud storage services, and internet based telecommunications.
The Guide excludes services which can be obtained without the use of information technology or which can be transmitted by email as digital services. Long-distance education services for preschool, primary and secondary education, tertiary education including vocational and professional training provided online by local or foreign service providers, as well as online services such as e-newspapers, educational, technical, scientific, historical or cultural journals and periodical reading materials are also not subject to Digital Tax. 14
Whilst the Guide is presently silent on financial technology solutions, based on the existing OECD discourse on the scope of digital services, and by drawing parallels to the examples raised in the Guide, digital banking services, e-commerce, e-banking and e-payment services would also likely to fall within the ambit of “digital service”.
FSPs providing digital service to consumers in Malaysia are advised to study the Guide which sets out various scenarios on how the implementation of Digital Tax affects them. Specifically, the Guide captures the following types of businesses and individuals as FSPs:
A business or individual who sells digital products to consumers in Malaysia directly (see Examples 3 and 4 of the Guide);
A business or individual who sells digital products to consumers in Malaysia indirectly through intermediaries, such as an online platform (see Example 5 of the Guide); and
A business or individual who operates an online platform making transactions on behalf of overseas service providers and issues invoices to consumers in Malaysia under its name (see Example 6 of the Guide).
With burgeoning pressure mounting on the OECD, the OECD now recognises that the digitalisation of the economy has strained the existing rules to a point where they are exposed to a serious risk of fragmentation and there is an urgency for the new proposed rules to be in place by 2020, 15 especially seeing a growing number of countries which have taken to unilateral measures or are departing from previously agreed standards, consequentially impacting an already fragile global economy and fraying multilateral relations between nations. 16 Hence, OECD has begun to hasten its footsteps to come up with the updated international tax rules, a proposed “Unified Approach”.
This proposed approach will address lacunas in existing international tax laws which are currently handicapped by tax rules constrained to physical presence. It will address and cater to new digital business models, where physical presence in a jurisdiction will not be required. 17 With this new approach, MNEs conducting sustained and significant business in places where they may not have a physical presence can be taxed in such jurisdictions18 as residual profits and corresponding taxing rights would be reallocated to countries where the consumers are based. 19
Considering the resistance by the US20 against major economies like France, UK and Italy, as well as its opposition against OECD’s proposed Unified Approach, it remains to be seen whether the proposed Unified Approach may be finalized by the end of 2020, and assuming so, reforms may have to be made to Malaysian tax laws to bring it in line with the Unified Approach.
All in all, the introduction of Digital Tax aims to widen Malaysia’s revenue base and level the playing field for local service providers with that of foreign service providers in the field of digital technology is in line with general global sentiments, though ultimately, in the Malaysian government’s bid for more revenue, Malaysian consumers will be the ones set to feel the cascading effects of the Digital Tax. 21
| 1 Article, The Star Online, The Biggest Threat to Malaysian Media? Facebook and Google, Report Finds, dated 28 Jan 2020, accessible at https://www.thestar.com.my/news/nation/2020/01/28/the-biggest-threat-to-malaysian-media-facebook-and-google-report-finds
2 Article, How Smart Choices On Taxation Can Help Close the Growing Fiscal Gap, by Aurelie Barnay, Jonathan Davis, Jonathan Dimson and Marco Dondi, dated November 2019, https://www.mckinsey.com/industries/public-sector/our-insights/how-smart-choices-on-taxation-can-help-close-the-growing-fiscal-gap
3 Article, The Edge Malaysia, Frankly Speaking: Digital Tax Hurts Malaysians, not FB or Google, dated 9 Dec 2019, accessible at https://www.theedgemarkets.com/article/frankly-speaking-digital-tax-hurts-malaysians-not-fb-or-google
4 Article, How Smart Choices On Taxation Can Help Close the Growing Fiscal Gap, dated November 2019, by Aurelie Barnay, Jonathan Davis, Jonathan Dimson and Marco Dondi, https://www.mckinsey.com/industries/public-sector/our-insights/how-smart-choices-on-taxation-can-help-close-the-growing-fiscal-gap
5 Article, The Wall Street Journal, Mnuchin Warns U.K., Italy Over Digital-Tax Plans, dated 21 Jan 2020 by Greg Ip and Paul Hannon, accessible at https://www.wsj.com/articles/mnuchin-warns-u-k-italy-over-digital-tax-plans-11579598943
6 Article, Reuters, U.S. warns of possible counter-measures against Czech digital tax, dated 24 Jan 2020 by Jason Hovet, accessible at https://www.reuters.com/article/us-europe-digitaltax-czech/u-s-warns-of-possible-counter-measures-against-czech-digital-tax-idUSKBN1ZN0ZN
7 Article, The New York Times, U.S. and France Race to Conclude Digital Tax Talks as Tariffs Threat Looms, dated 7 Jan 2020 by Ana Swanson and Alan Rappeport, accessible at https://www.nytimes.com/2020/01/07/business/economy/us-france-digital-tax.html
8 Article, The Wall Street Journal, Mnuchin Warns U.K., Italy Over Digital-Tax Plans, dated 21 Jan 2020 by Greg Ip and Paul Hannon, accessible at https://www.wsj.com/articles/mnuchin-warns-u-k-italy-over-digital-tax-plans-11579598943
9 Article, The Edge Financial Daily, Five Ways To Prevent Double Taxation from Digital Tax, dated 31 December 2019 by Chester Tay, accessible at https://www.theedgemarkets.com/article/five-ways-prevent-double-taxation-digital-tax
10 Paragraph 10 of the Guide
11 Working Paper No. 843 by the Value Added Tax Committee of the European Commission, Directorate-General of Taxation and Customs Union dated 12 Feb 2015 (taxud.c.1(2015)694775-EN)
12 Working Paper No. 882 by the Value Added Tax Committee of the European Commission, Directorate-General of Taxation and Customs Union dated 28 Sept 2015 (taxud.c.1(2015)4459580-EN)
13 Working Paper No. 896 by the Value Added Tax Committee of the European Commission, Directorate-General of Taxation and Customs Union dated 9 Feb 2016 (taxud.c.1(2016)922288 – EN)
14 Article, The Edge Financial Daily, Five Ways To Prevent Double Taxation from Digital Tax, dated 31 December 2019 by Chester Tay, accessible at https://www.theedgemarkets.com/article/five-ways-prevent-double-taxation-digital-tax
15 Statement, Statement by the OECD/G20 Inclusive Framework on BEPS on the Two-Pillar Approach to Address the Tax Challenges Arising from the Digitalisation of the Economy, as approved by the OECD/G20 Inclusive Framework on 29-30 January 2020, document available for download at https://www.oecd.org/tax/beps/international-community-renews-commitment-to-multilateral-efforts-to-address-tax-challenges-from-digitalisation-of-the-economy.htm
16 OECD Secretary -General Tax Report to G20 Finance Ministers and Central Bank Governments in October 2019
17 Article, International Tax Review, OECD Releases Updated Proposals onDigital Era Taxation, dated 24 Oct 2019 by Mark Martin and Thomas Bettge, accessible at https://www.internationaltaxreview.com/article/b1hqpxyr75mfrq/oecd-releases-updated-proposal-on-digital-era-taxation
18 Update, International Community Renews Commitment to Multilateral Efforts to Address Tax Challenges from Digitalisation of the Economy, OECD, accessible at https://www.oecd.org/tax/beps/international-community-renews-commitment-to-multilateral-efforts-to-address-tax-challenges-from-digitalisation-of-the-economy.htm
19 Public Consultation Document: Secretariat Proposal for a “Unified Approach” under Pillar One from 9 October 2019 to 12 November 2019
20 See the letter from US Treasury Secretary Steven Mnuchin to OECD Secretary-General José Ángel Gurría dated 3 Dec 2019
21 Article, The Edge Malaysia, Frankly Speaking: Digital Tax Hurts Malaysians, not FB or Google, dated 9 Dec 2019, accessible at https://www.theedgemarkets.com/article/frankly-speaking-digital-tax-hurts-malaysians-not-fb-or-google
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