Monday, 23 October 2017

Thoughts for taxing the digital economy

Dave Namasivayam Ananth is a senior lawyer, a former Magistrate and advocate in Malaysia before taking up a position with the Inland Revenue Department in New Zealand as a Prosecutor. He now practises as a Tax Barrister, based in Auckland. He is an expert on Malaysian GST and a familiar speaker on the local Malaysian circuit, spending considerable time in Malaysia with a consulting firm working on GST. He also writes extensively on GST in Malaysia. He can be reached at davetaxnz@gmail.com.


There has been a lot of hype about the digital economy recently.  The Director General (DG) of the Royal Malaysian Customs Department (RMCD) clearly stated on 18 September 2017 that the GST Act 2014 will be amended to capture the GST impact on the digital economy. In New Zealand, this tax, sometimes also called the “Netflix tax”, came into force 1 October 2016. This tax is paid by the consumers of the product and not by the company.

I note the changing nature of doing business – the standard way will eventually give way to the digital economy. Tax collection year-on-year is declining, and that is likely to do with this new e-commerce way of doing business and the permanent establishment requirement. Therefore, we must recognise that GST on digital services is yet another example of digital transformation. It is here to stay and will get more complex as the style of doing business evolves to the next level.  
GST has always been intended as a broad-based tax on the consumer which is intended to cover the vast majority of transactions[1]. Virtual goods are increasingly commonplace (eg, Netflix, Uber, Alibaba, etc.) so they should not be exempt. It should be noted that these companies providing goods did not come up with some cunning tax plan to avoid charging it; they were just operating within the way the rules worked until the recent law change[2]. No one would have thought the rules of the game will change this soon. However, the GST committee, when introducing the first draft of the GST Bill in Parliament in 2009, should have considered the fact that e-commerce was already in place and downloading of software was a common occurrence at that time. Even if that was too early, the drafters could have included it in 2014 when the Bill became law. We have been living in the digital age for some time and the government needs to catch up with times.

Should the government choose to tax digital services, these are some points to be considered:

Contracts made online

Any amendments to the GST Act 2014 would also need to address contracts made online. The time and place of offer, and acceptance of such contract may be different from the conventional treatment and this may need to be considered to determine the correct tax effect, ie where the time and place of supply is. From the basic contract law, where you sell a product is an "invitation to treat", followed by an "offer to buy" from the potential purchaser, and acceptance of the offer to buy, by the seller. The contract is finally made at the time and place the acceptance by the seller is communicated to the potential purchaser.

Definition in GST Act

I must stress the definition of words in the legislation is paramount to give effect to the intent and purpose of the legislation.
What will be the definition of remote services? A wide definition of services should be in place, where it includes both digital and traditional consultancy services. For example, the New Zealand GST Act defines “remote services” as a service that, at the time of the performance of the service, has no necessary connection between the place where the service is physically performed and the location of the recipient of the services. The New Zealand GST Act also provides rules on determining residence and status of recipients with respect of remote services.
In any case, the definition should ensure that offshore suppliers will be required to register and submit a GST return if their supplies of services to Malaysian consumers exceed the RM500,000 threshold in a 12-month period. 

Enforcement

Enforcement will be challenging RMCD and Inland Revenue Board (IRB) will need a good IT system in place as well as money to be spent on training and expertise to manage this new source of revenue.
Because, say for argument’s sake, I register for cloud services internationally and I am not paying GST on those services. However, I don’t have an issue paying GST for those services. How does the government enforce compliance? How does RMCD know that I have cloud and where it is? It is a nightmare, in my view.
Companies like Netflix, Adobe and Uber would consider compliance a component of their corporate responsibility, however, not all are like that.

Effect on businesses

Every time new laws are implemented, there is a compliance cost to businesses which inevitably will be passed on to the consumer.  In eagerness to maximise the collection of revenue, we tend to forget the competitiveness of the world around us and what businesses go through.  To the taxpayer, this is a significant change from the normal way GST operates, as the GST rules will be ignoring the legal structure of the agent / principal relationships of the parties[3].
I think more concerted effort must be put in place to get all stakeholders and the public to understand and give proposals (public submissions) to the issues at hand. Perhaps the RMCD or Ministry of Finance can consider adopting the Central Bank of Malaysia (BNM) or the Inland Revenue Authority of Singapore (IRAS)’s method of drafting to introduce new and/or amended legislation.
BNM obtains feedback from the relevant stakeholders and the public in respect of any proposed frameworks, regulations, etc. vide exposure drafts, discussion papers and concept papers. IRAS obtains feedback from the relevant stakeholders and the public on any proposed changes and new adoptions of tax treatment through the use of public consultations. It then releases a summary of the responses received and the corresponding feedback.
A key task would be to ensure that the final form of the GST legislation is able to work in an efficient and effective manner in the real world, ie it allows for the collection of GST, without causing unnecessary costs or delays to the Malaysian consumers or foreign suppliers. More importantly, it should not cause foreign businesses to withdraw from the Malaysian market if our rules become too cumbersome. Please do be business-focused and user-friendly, what more now the government has implemented the Digital Free Trade Zone (DFTZ).
I hope that the new amendments will ensure that compliance costs are minimised as it will only apply to business-to-consumers (B2C) transactions.  Any increase in cost will inevitably to passed on to the consumers. Business-to-business (B2B) transactions are already covered under the reverse charge mechanism. The new amendments must also prevent double taxation from arising on supplies of remote services performed in Malaysia to a non-resident consumer, by allowing a deduction against the supplier’s liability for Malaysian GST to the extent that the supply has already been taxed in another jurisdiction.

Netflix tax in foreign jurisdictions

The GST rules on online services came into force on 1 October 2016 in New Zealand. GST is collected on services and intangibles (including digital downloads) supplied remotely by foreign suppliers to New Zealand-resident consumers. The new rules also apply to insurance and remote gambling services provided by foreign suppliers. The foreign businesses will need to register and collect GST while New Zealand consumers who purchase or subscribe to such services will likely bear the increased costs. 
The rules do not cover the collection of GST on the purchases of goods online from overseas.  This is a more complex issue that is still being considered by New Zealand Customs and Inland Revenue separately[4]. In Malaysia, I envisage the same.
Norway has moved ahead in this direction with their “VAT on electronic services” (VOES) scheme since their law change in 2011.  A dating service, a foreign company, in 2017, was assessed approximately USD3.8 million including penalties and interest, for failure to report and pay VAT on its electronic dating services sold to Norwegian consumers. The law requires all foreign companies supplying electronic services to Norwegian consumers regardless of the permanent establishment requirement to report VAT at a standard rate of 25% on all sales.

Permanent establishment

Now, there appears to be the permanent establishment issue which needs to be addressed, established in the income tax regime. Tax laws need to move with times, obviously due to the globalisation and digitalisation of the businesses. E-commerce is now the in thing – governments need to address this issue and as consultants, we cannot hide behind archaic rules. Malaysia, like New Zealand, is a member of the Organisation of Economic Cooperation and Development (OECD) and has been involved in issues relevant to e-commerce.
One OECD report, "Clarification on the Application of the Permanent Establishment Definition in e-Commerce", released in December 2000, concluded that a website does not in itself constitute a permanent establishment, but a server could be a permanent establishment if it is an essential part of an online business activity. This can mean that internet service providers or Malaysian businesses who own servers overseas and conduct all their business online may have to file tax returns in the country where their equipment is based, even if the business does not base staff there[5].
There are proposed rules to get around the conservative permanent establishment requirement[6] – that is to deem a non-resident entity to have a permanent establishment in Malaysia if a related entity carries out sales-related activities for it here. This permanent establishment will be deemed to exist for any applicable double tax agreement (DTA). This deeming provision is essential to get around the permanent establishment regime. However, the mechanism of this needs to be studied before the law is drafted. A good place to start would be to peruse the existing papers and studies on this subject.

What is next?

As much as Malaysia will be amending the GST Act 2014 to cover these digital transactions, Malaysian companies operating in a similar way, supplying to overseas customers will eventually need to also register in other jurisdictions for GST/VAT. Malaysian digital service providers that cater to overseas customers will have to be ready for GST/VAT whether they like it or not. Again, Malaysia is not the first country neither will it be the last to tax on e-commerce.
Rather than making piece meal amendments to Revenue Acts, I suggest an in-depth study by experts in the field. Engage them and get it right. Taxpayers want to know their tax obligations and how much they need to spend on compliance including IT infrastructure. Taxpayers want to pay GST but only if it is the right amount according to clear law.



[1] Jackson, Donovan. “Netflix tax: Why digital goods belong in the IRD’s net.” istart.co.nz. iStart, 6 Oct. 2016. Web. 11 Oct. 2017.
[2] Ibid
[3] Bullot, Allan and Hornbrook, Sam. “GST: Online purchases – What will be caught and when? Tax Alert - September 2015.” www2.deloitte.com. Deloitte, n.d. Web. 11 Oct. 2017.
[4] du Buisson, Jeanne and Pahwa, Divya. “GST on “remote” services Tax Alert - April 2016.” www2.deloitte.com. Deloitte, n.d. Web. 11 Oct. 2017.
[6] “BEPS – Transfer Pricing and Permanent Establishment Avoidance.” http://www.ird.govt.nz/. Inland Revenue.  Web. 17 Oct. 2017.

No comments:

Post a Comment