Malaysia's Taxation System: Contemporary Practices, Issues and Future Direction

CHAPTER 1: Introduction to Taxation in Malaysia

Mohamed Ariff, Sunway University; Yeah Kim Leng, Sunway University

Malaysia is an upper middle-income country with a per capita income of USD9,500 in 2018. This was a higher figure in 2014 before the Malaysian Ringgit started to decline in 2015.¹ The resultant stream of total tax collection increased in the 1980s after the successful industrialisation of the country. Meanwhile, the ratio of tax-to-gross domestic product (GDP) has been declining since 1987 to 17 percent, but subsequently rose to 20 percent with the implementation of the goods and services tax (GST) in 2015 (which has been zero-rated as of June 2018). A typical high-income Organisation for Economic Co-operation and Development (OECD) country has a tax-to-GDP ratio of 32 percent. Malaysia’s November 2018 budget estimate of government revenue is approximately RM275 billion, which is about 21 percent of the country’s aggregate income. With the zero-rating of the GST, the government revenue would shrink by some RM44 billion in 2019. Several countries at a similar stage of economic development, such as Thailand, are collecting lower amounts of revenue (17.4 percent) than Malaysia.

Malaysia’s taxation system began in the fifteenth century when the Malacca Sultanate, a maritime power, developed a system based entirely on trade and wealth. In 1920, the then British rulers of Malaya imposed the modern taxation system in the country, which was further improved when Malaya gained independence in 1957. The current modern taxation system leans more on income and less on wealth.

Malaysia’s Income Tax Act 1967 incorporated the need for changes when Sarawak and Sabah joined to form Malaysia in 1963. Since then, the law aims to garner revenue based on taxing incomes in the form of personal income tax, corporate income tax, capital gains tax, and dividend tax (fully repealed since 2017). There are also indirect taxes such as import and export taxes, sales and service tax (SST), and petroleum income tax. The country’s taxation authorities are the Inland Revenue Board of Malaysia (IRBM), which oversees direct taxes, and the Royal Malaysian Customs Department (RMCD), which oversees indirect taxes. At the time of writing, the direct tax revenue of the Malaysian government is 53 percent while indirect taxes account for 47 percent of total tax revenue, evidencing the country’s reliance on direct taxes.

This book on Malaysia’s taxation was conceived as a primer for scholars, students, practitioners, and policymakers alike. Divided into two parts, the chapters in this book are contributed by legal, accounting, and tax administration professionals, and academics who specialise in taxation studies. Part I provides a perspective on government revenue with the theme taxation in practice, zooming into the intricacies of the taxation system and how it is being administered. Part II examines taxation on a broader level, analysing the country’s policies and taxation system in comparison to other countries.

Part I starts off with an overview of Malaysia’s contemporary taxation laws and practice in Chapter 2. Providing references to significant case laws, this chapter details the country’s five prominent taxes—income tax, real property gains tax (RPGT), SST, petroleum income tax, and stamp duty—along with other tax legislations such as Customs Act 1967, Local Government Act 1976, and Tourism Tax Act 2017. The authors of this chapter point to the fact that the existing laws provide room for other forms of taxation to be introduced.

The ensuing Chapter 3 examines the challenges faced by taxpayers arising from the complexity of a taxation system and the implementation of new taxation laws. The chapter focuses on tax compliance and how compliance cost is incurred by taxpayers, now that tax computing and reporting are done through the Self-Assessment System (SAS). The chapter also highlights the measures taken by tax authorities to reduce taxpayers’ compliance burden and simultaneously improve voluntary compliance, such as tax education and awareness programmes, and tax simplification methods. In addition, the chapter provides a brief discussion on the new SST implemented in September 2018 to replace the GST.

In Chapter 4, key challenges faced by tax authorities in terms of tax collection are discussed. The primary obstacle to tax collection is non-compliance, either intentional or unintentional, which not only reduces the amount of collected tax (and hence, revenue) but also incurs extra cost for tax authorities to counter and penalise such behaviour. The chapter also describes significant historical milestones in the country’s taxation system development and sheds light on the tax collection processes of the IRBM and RMCD.

Chapter 5 focuses on taxation issues involving deferred income (payment received in advance for goods or services not yet rendered) following the controversial amendments made to Section 24 of Income Tax Act 1967. The chapter questions the practicality of the amendments, which make deferred income taxable upon receipt instead of on an accrual basis, and argues that these amendments are in line with neither conventional tax principles nor accounting standards. The authors of this chapter recommend for the amendments to be suspended until further refinements are made.

While the previous chapters discuss the taxation system and its administration at length, Chapter 6 examines talent management in the IRBM and how the tax authority transforms its employees into efficient tax professionals. From recruitment and training to development and retention, this chapter analyses the IRBM’s approaches in managing its workforce. Proper talent management and workplace leadership are important areas for any tax authority to develop, as an efficient taxation system is only made effective with the people that govern it.

Part II, which covers national policies and cross-country perspectives, begins with a bottom-up perspective on taxation through its intertwining relationship with fiscal and monetary policies in Chapter 7. Taxation, fiscal policy, and monetary policy work in tandem towards influencing economic growth, and changes in one without considering the other two could harm the economy instead. The chapter also details the major fiscal policy changes Malaysia had made throughout the decades since the 1970s, and the crises that shaped them.

Chapter 8 is a multi-country study of taxation. The chapter compares the taxation system in Malaysia to that of Japan, Korea, the Philippines, Singapore, Indonesia, and the OECD countries. The chapter provides insights into the different tax structures each country has adopted and how these structures have influenced the country’s tax ratio and economic growth.

In a similar fashion, Chapter 9 provides a critical analysis of the Australian taxation system as a reference point for Malaysia. The chapter discusses the significant reforms Australia has undergone in the past 30 years in the areas of tax law, tax policy, and tax administration. These reforms have transformed the Australian Taxation Office from an average tax administrator into a leading one. This chapter offers valuable lessons for Malaysia and its taxation system, especially since the country aspires to be a high-income nation such as Australia.

Finally, Chapter 10 concludes the book with possible tax reforms and strategies to transform the country’s current taxation system into a better one. Written by a tax professional who has been at the helm of taxation for decades, the personal views expressed in this chapter could be considered radical to some readers. However, in a country straddling between the upper-middle income and high-income divide, perhaps extensive changes are needed for the country’s taxation system to move onwards and upwards.

Chapter 1 Footnotes

[←1]

The Malaysian Ringgit fared well when the economy was growing, right up to the end of 2014 when the currency value was high enough that the per capita income was USD11,200. The currency has since depreciated by 8.5 percent and as such, per capita income has declined over three years to USD9,500 per capita. The high-income economic status to which this country aspires is defined as one that has a per capita income of USD12,600 or more (as of 2018). To reach that high-income threshold, the per capita income of the country has to improve from the current level by 32 percent. It is a long road ahead to that endpoint.

CHAPTER 2: Contemporary Taxation Laws and Practice

Kanchana Chandran, Sunway University; Kalpana Chandran, Hogan Lovells Int. LLP; Paul Linus Andrews, Sunway University

Abstract This chapter offers a summary of the various types of taxes in Malaysia—income tax, real property gains tax, sales and service tax, petroleum income tax, and stamp duty—which are each governed by a separate and distinct legislation. Other taxation legislations such as the Customs Act 1967, the Local Government Act 1976, and the Tourism Tax Act 2017 are also examined. This chapter provides an insight into the historical background and development of tax cases heard in recent times by the Malaysian courts, highlighting some key changes that have taken place in taxation laws. It concludes by surmising that the various types of taxes and the strict penal sanctions imposed on tax defaulters augur well for the nation’s government in securing its revenue.

1.0 Introduction

In arriving at decisions on taxation law in post-independent Malaysia, courts tend to rely on English authority as well as decisions of other Commonwealth jurisdictions. For instance, the use of the English case Mersey Docks and Harbour Board v. Lucas¹ by the Malaysian Court of Appeal in Syarikat Jasa Bumi (Woods) Sdn. Bhd. v. Ketua Pengarah Hasil Dalam Negeri² indicates the influence of English precedents in the country. The Court of Appeal in Syarikat Jasa Bumi had, in deciding what would constitute the gains of a trade and thereby profit within the meaning of Malaysia’s Income Tax Act 1967, referred to the decision of the House of Lords in the case of Mersey Docks. The Court of Appeal, however, held that the decision in Mersey Docks was not applicable to the facts in Syarikat Jasa Bumi. Nonetheless, the Mersey Docks decision remains an instructive reference point by our courts in arriving at decisions on taxation law.

Likewise, the Court of Appeal in Syarikat Ibraco-Peremba Sdn. Bhd. v. Ketua Pengarah Hasil Dalam Negeri³ had occasion to refer to a New Zealand decision in the case of Commissioner of Inland Revenue v. Challenge Corporation Limited⁴ when considering Section 140 of Malaysia’s Income Tax Act 1967, which is in pari materia with Section 99 of the New Zealand Income Tax Act 1976 on the material distinction between tax avoidance and tax mitigation. This will be further discussed in subsection 3.5.

The Malaysian courts have, however, tended to differ from the decisions of foreign jurisdictions to suit the local context⁵ where there are fundamental differences between local tax structures and that of foreign jurisdictions.

2.0 The Various Types of Taxes in Malaysia

The following are prominent types of taxes imposed in Malaysia that are governed by different legislations:

Income tax⁶

Real property gains tax (RPGT)⁷

Sales and service tax (SST)⁸

Petroleum income tax⁹

Stamp duty¹⁰

There are also provisions in the law for other types of taxes to be introduced in Malaysia, as agreed between the Malaysian government and the Inland Revenue Board of Malaysia (IRBM).

3.0 Income Tax

3.1 Charging Provisions under Income Tax Act 1967

Under Income Tax Act 1967, there are provisions for tax to be charged on income derived in Malaysia by individuals and/or entities who are residents in Malaysia, as well as non-resident individuals and/or entities. These provisions, described as the charging provisions of the Act, were considered by the Court of Appeal in Ketua Pengarah Hasil Dalam Negeri v. Teraju Sinar Sdn. Bhd.¹¹ This case involved Union Concept Manufacturing Pte. Ltd., a non-resident Singaporean company, that provided handling and repacking services to a Malaysian company. The Court of Appeal held that the charging provisions of the Act, which specify the party liable to pay tax, obliged the Malaysian company to withhold the tax payable by the Singaporean company on income derived in Malaysia for the services rendered.¹²

3.2 Income Tax Offences

Table 1 summarises the penalties imposed under Income Tax Act 1967 for income tax offences.

Table 1 Penalties for offences under Income Tax Act 1967

Source: Data from IRBM (2011).

3.3 Canons of Construction of Taxation Legislation

The meaning of complex written legal instruments such as contracts and legislation is not always unequivocal. In circumstances where the courts have to resolve legal ambiguities, they may seek the aid of textual and substantive rules or maxims governing the interpretation of the law. This set of guidance is referred to as canons of construction.

In the context of taxation legislation, the Malaysian courts have consistently utilised the canons of construction as applied in other jurisdictions (e.g., England, Australia, and India) when confronted with the operation of Income Tax Act 1967 provisions as shown in Table 1 or any other provision thereof. In the case of Lembaga Hasil Dalam Negeri Malaysia v. Alam Maritim Sdn. Bhd.,¹⁶ the Federal Court of Malaysia held that the intention of Parliament must be construed from the language used and be interpreted by the court accordingly.

In other words, where the language of a tax provision is plain and unambiguous, the court must give effect to that meaning alone. However, if the words of a tax provision are not explicit, it is incumbent upon the court to seek the purpose of Parliament without sacrificing justice or importing the absurd. This approach is commonly referred to as the purposive approach to statutory interpretation.

3.4 Overruling the Decision of the Director General of Inland Revenue

The administration of income taxes in Malaysia is under the management of the Director General of Inland Revenue (DGIR) of the IRBM. Despite his authority, there are precedents which show that his decisions have been challenged by the courts. For instance, in Ketua Pengarah Hasil Dalam Negeri v. Nimble Solutions Sdn. Bhd.,¹⁷ the High Court disagreed with the decision of the DGIR in imposing penalty for the submission of an incorrect return by the taxpayer.

The case involved Nimble Solutions, a resident company in Malaysia, that had exported information and communication technology (ICT) services to a foreign client in Taiwan. According to the Income Tax (Exemption) (No. 9) Order 2002, Malaysian residents can be exempt from income tax payment in respect of income derived from the export of qualifying services specified in Schedule 3 of Income Tax Act 1967 in the basis period for a year of assessment and in an amount and manner prescribed by the order. The ICT services in this case fell within the expression of qualifying services, thus the resident company claimed exemption pursuant to the order.

In the year of assessment (2007), the resident company exported ICT services to the tune of RM387,200. There was, however, no export of qualifying ICT services in the previous year of assessment (2006). The IRBM subsequently refused to grant exemption as the export sales had taken place only in 2007 which constituted as the company’s first export sales. The IRBM proceeded to impose additional taxes, including a penalty, on the resident company.

The High Court found that the IRBM had misinterpreted the exemption order and ruled that the taxpayer was fully entitled to claim for the exemption.¹⁸ Accordingly, this decision demonstrates that the Malaysian courts will not hesitate to overrule the IRBM in cases where its decisions are not consistent with the intent of Income Tax Act 1967 provisions and/or any regulation or order emanating therefrom, if the interest of justice so demands.

3.5 Distinction between Tax Evasion, Tax Avoidance, and Tax Mitigation

The Malaysian taxation law, like in other jurisdictions, makes a distinction between tax evasion, tax avoidance, and tax mitigation. Table 2 outlines the key differences and recent cases related to tax evasion, tax avoidance, and tax mitigation. Some of the cases in Table 2 serve as the same sources of reference in determining whether a particular arrangement amounts to a tax avoidance or mitigation.

Table 2 Distinction between tax evasion, tax avoidance, and tax mitigation

The responsibility is on the taxpayer to demonstrate that the arrangement by which its income is produced complies with the requirements of the law or accepted business practices so as to limit risk exposure, and that tax saving is purely incidental. Under Income Tax Act 1967, if the taxpayer’s arrangement by which its income is produced is found to be evading taxes and altering tax incidence, the DGIR is empowered to impose the tax payable on the arrangement in addition to penalties.²⁸

3.6 The OECD and Its Impact on Malaysian Taxation Laws

The Organisation for Economic Co-operation and Development (OECD) is a unique forum comprising 35 member countries that work together and with non-member countries to promote economic growth, prosperity, and stability through policy comparison and coordination of a range of issues including tax matters.

Although Malaysia is not an OECD member, some Income Tax Act 1967 provisions were designed to be in line with OECD policies. For example, the provisions on Double Taxation Arrangements with foreign nations (Sections 132 and 133, and Schedule 7), and withholding taxes (Section 109B). Malaysia’s taxation law was amended in 2017 to implement the Base Erosion and Profit Shifting (BEPS)²⁹ Action 13 on country-by-country reporting by the OECD. This is an encouraging reflection of Malaysia’s willingness to keep abreast of global developments, as the OECD has reported that national laws have not always kept pace with global developments.

3.7 Double Taxation Agreements

A Double Taxation Agreement is a contract signed between two countries to avoid their residents from being doubly taxed on the same income from cross-border trades and transactions. Thus, resident taxpayers of the countries under the agreement will be able to claim double tax reliefs to minimise their tax burden on foreign income.

In the Teraju Sinar case³⁰ mentioned earlier in the chapter, the Malaysian company had engaged the services of the Singaporean company for the following years of assessment: 1998, 1999, 2000, and 2002. Under Section 109B of Income Tax Act 1967, the Malaysian company was obliged to deduct withholding taxes from its payments to the Singaporean company³¹ but it failed to do so.

As a result, the DGIR brought a claim against it, including a claim for additional assessments. The Malaysian company argued that the Singaporean company was relieved of the liability to pay tax due to the Double Taxation Arrangement between Malaysia and Singapore. However, the Court of Appeal held that the exemption from the liability to pay tax under the Double Taxation Arrangement was an exemption accorded to the Singaporean company, not the Malaysian one.

3.8 Withholding Tax

Withholding tax is the amount of tax withheld by a resident payer on the income earned by a non-resident payee. Having deducted tax from payment at a prescribed rate, the payer will have to remit it to the IRBM within one month of payment being made.

In the Alam Maritim case³² regarding the Income Tax Act 1967 provision to withhold tax, the Federal Court of Malaysia held that the intention of Parliament to collect tax from non-residents who have received payments from Malaysians would be rendered ineffective, unless associated provisions were also promulgated to allow the collection of tax at source. This tax collected at source is what is referred to as withholding tax under Section 109B of the Act.

In Ketua Pengarah Hasil Dalam Negeri v. Thomson Reuters Global Resources,³³ a claim by the DGIR against a Switzerland party for withholding tax in respect of services provided to a Malaysian company was dismissed by the High Court. This decision was reached due to the Switzerland party not having a permanent establishment in Malaysia, and how it was wrong to impose withholding tax on fee received as distribution fee in Malaysia. The High Court