In the modern world, there is undoubtedly a lack of domestic tax rules which brings to tax profit from digital services rendered overseas without a physical presence in the relevant country. To counter this, service tax on digital services (DST) was introduced.
Tax challenges of the digital economy
In 2021, 136 countries in the OECD/G20 Inclusive Framework on the BEPS project had reached an agreement to the two-pillars solution.
Members must reallocate some taxing rights from a multinational enterprise (MNE)’s home country to market jurisdictions where it has business activities and profits, regardless of whether the firm has a physical presence in those jurisdictions.
Certain MNEs will be subject to a minimum tax rate of 15%.
There is a disparity in the reaction by participating countries such as the US, Singapore, India, Indonesia, Austria, Italy and Norway in response to the two pillars solution.
Malaysia is one of the pioneer countries in South-East Asia, having extended the scope of its indirect tax to cover the supply of foreign digital services. As of July 31 2020, there are approximately 248 registered foreign services providers (FSP) in Malaysia. The Malaysian government through the Royal Malaysian Customs Department has collected approximately RM 427.6 million ($101 million) in revenue from DST last year.
From January 1 2020, a FSP is required to pay services tax at the rate of 6% on the digital services that it provides to a consumer in Malaysia. Digital services will only be subject to service tax at 6% if their value exceeds RM 500,000 for a period of 12 months. The service tax will be accounted for by the consumer at the time when the payment is received by the FSP and to be remitted to the Customs.
The implementation of DST raises concerns about local businesses in Malaysia due to the wide definition of ‘consumer’ under the Service Tax Act 2018 (STA). It does not seem to be consistent with the Parliament’s intention of creating a competitive environment for local and foreign suppliers as it increases the cost of business by foreign service providers.
Another concern raised is that Malaysian businesses could be subject to double taxation if the same service falls within the ambit of ‘digital services’ and ‘imported taxable services’. In order to mitigate double taxation, several measures were introduced such as B2B exemption under Service Tax (Persons Exempted From Payment of Tax) Order 2018 (the Exemption Order) and intra-group relief.
A Malaysian company that acquires digital services from FSP which is subject to service tax is exempted from self-accounting for service tax. As a result, the imported digital services would only be subjected to service tax for only once if the stipulated conditions are fulfilled.
Enforcement of the DST
To date, there are no reported cases in Malaysia in respect of DST-related matters. As most FSPs do not have any legal presence in Malaysia, it remains uncertain as to how customs will enforce the new digital tax regime at this juncture.
It is foreseeable that customs will face difficulties to identify the type of digital services that fall within the ambit of the STA due to the wide definition of the word digital service’. No clear measures in the enforcement of the DST are in line with the existing double taxation treaties with other countries that were proposed.
As the law in respect of DST is still evolving, it is pertinent for the FSP to keep abreast of the updates. In view of the above, it is crucial for businesses to maintain proper documentation in ensuring compliance under the STA.
As stipulated under the STA, failure to comply with the provisions is an offence and subject to penalties. Examples include the failure or late application for registration, late payment of service tax on digital service, failure to keep records, etc. In this regard, FSPs are encouraged to seek consultation from tax solicitors to ensure compliance with local regulations and to preserve their rights.
While customs has the power to sanction non-compliant companies. It should be noted that such power must be within the jurisdictions accorded by the STA.
As Malaysia is one of the countries that has imposed DST, this may undermine tax certainty and investments and increase the compliance and administration cost of the MNEs. As such, it is noteworthy to observe the development of the legislation change in Malaysia considering the recent agreement in the two-pillars solution to guarantee tax certainty, which is essential to the economy.
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