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Tax Law – Service Tax on Digital Services

April, 2019

With the increase of Malaysia’s internet infrastructure, through policy changes around recent increases in bandwith and internet speeds, as well as the increase of accessibility to international-based digital (web and app based) services, the Malaysian public, both business and individual alike, have enjoyed a vast array, and ever growing number, of these services in recent years.

The increase in accessibility has created growth in several sectors through, for example:

  • Competition and competitive pricing;
  • Local innovation and entrepreneurship, through being inspired to create Malaysian-based services which compare and compete with these digital services;
  • Sector-based efficiencies through digital tools and productivity; and
  • Personal leisure and entertainment options.

The Malaysian Government, whilst in support of these digital services, has faced a distinct policy issue. The Malaysian Government has not been in a position to collect any national tax revenue from the people’s consumption of these services – due to it being a service offered to Malaysians from a foreign-based entity. For example, you will notice that there are no Service Tax charges on your Spotify or Netflix bill.

This created the need for implementation of a national tax system to accommodate the surges of local consumption of these digital services, whilst contributing to the country’s coffers.

What is digital tax?

Digital tax is a taxation of the borderless digital economy. The rapid growth in technology enabled businesses to provide their services to the other side of the world within seconds. This resulted in a lot of cross-border digital activities which created massive value but was not being taxed. Many countries across the globe, including Malaysia, are only now catching up, with other nations that have implemented digital taxation regimes, and creating policy and legislation aimed at taxing the digital economy.
Digital taxation is not a novel idea, with many other countries such as Japan (8%), South Korea (10%), New Zealand (15%) and Russia (20%) already having similar taxes in place. Malaysia is the second South East Asian country which announced that it will be introducing a digital tax, the first being Singapore.

Inequality for service providers

Currently, local Malaysian digital service providers (which meets the prescribed threshold) such as iFlix and Astro are required to register for, and charge consumers six percent (6%) service tax on each invoice. The problem is foreign digital service providers such as Netflix, Spotify and Steam are not required to.

To address this inequality, amendments needed to be made to the current Service Tax Act 2018 (the “Act”).

Service Tax (Amendment) Bill 2019

The Service Tax (Amendment) Bill 2019 (“the Bill”) was recently passed by the Lower House of Parliament (Dewan Rakyat) on 8th April 2019. Once the Bill is passed by the Upper House of Parliament (Dewan Negara) and receives the Royal Assent, the Act will be effectively amended to, amongst others, impose a 6% service tax on the consumers of digital services from foreign service providers.

The Bill proposes for the following new definitions, amongst others, to be added into the Act. These definitions will be the deciding factor in determining which foreign businesses be affected by the introduction of this new tax.

Digital Service means 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;
Foreign Service Provider means any person who is outside Malaysia providing any digital service to a consumer and includes any person who is outside Malaysia operating an online platform for buying and selling goods or providing services (whether or not such person provides any digital services) 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;

The amendments to the Act is set to take effect on 1st January 2020. Foreign service providers will be required to register for service tax with the Royal Malaysian Customs Department (“Malaysian Customs”) if their total annual fees received from Malaysian consumers is expected to exceed, or exceeds RM500,000.00.

The Issues of Registration

Under the amendment, registered foreign service providers would be required to charge 6% service tax on the digital service that is provided to their Malaysian consumers starting 1st January 2020, which will in turn be remitted to the Malaysian Customs by the last day of the month following the end of the taxable period.

Foreign businesses which collect annual fees of over RM500,000.00 from their consumers in Malaysia should undertake the exercise of evaluating if the services they provide fall within the ambit of the definition of “digital service” as provided in the table above. It is likely that “digital service” will include:

  • Digital content streaming sites;
  • Software subscription;
  • Cloud storage services; and
  • Digital advertising services.

Affected foreign businesses should also use the given leadtime to seek for clarification and advice on compliance if needed; study the potential impact of the imposition of the tax on their consumers in Malaysia, and if their businesses will be adversely affected. The 6% service tax is likely to make Malaysians sensitive to any increase in prices of the digital service, and foreign digital service providers may have to address the choice of:

  • Increasing subscription fees and run the risk of losing subscriptions; or
  • Absorb the 6% as part of the end-price to consumers, which shall reduce their revenue by that amount.

Although the exact model and mechanism of registration that Malaysia will be adopting is still unclear, it may be helpful to look at fellow Asian countries. In Singapore, foreign entities are required to register via an overseas vendor registration regime. In Japan, the foreign business has the option of either setting up an office in Japan, or to appoint a tax representative and a tax agent.

Enforcement

There are doubts about the enforceability of digital tax, for amongst others, the following reasons:

  • Many small to medium sized foreign digital service providers are likely to not have any incentive to register for the tax;
  • There are questions as to how the Malaysian Customs would be able to detect if a foreign service provider collected an amount of fees which totals to more than the prescribed threshold; and
  • The application of the consumption tax on a Business-to-Business and a Business-to-Consumer context, and the delineation of the same by way of exemptions to avoid double taxation

Foreign service providers will be required to be registered with the Malaysian Customs and remit the necessary tax payments starting 1st January 2020, the same time the tax on international digital services is set to come in effect in Singapore.