2007 GST to be broad-based


  • Business
  • Thursday, 14 Apr 2005

Today we publish the first of a series of four weekly articles on the issue related to goods and service tax (GST) and its impact on selected industries and services. In the first instalment, Bhupinder Singh discusses the impact of the tax on financial institutions in Malaysia. 

The Goods and Services Tax (GST) to be implemented in Malaysia from Jan 1, 2007 will be a broad-based tax on most supplies of goods and services consumed in Malaysia as well as on goods imported into the country. 

All supplies are classifiable into taxable and non-taxable supplies. Taxable supplies consist of standard rated and zero rated supplies whilst non-taxable supplies cover exempt supplies and out-of-scope supplies. 

Registered traders of standard rated and zero-rated are allowed to claim input tax on taxable inputs for use in the making of their taxable supplies whilst exempt supplies and out-of-scope supplies are generally not input tax claimable. 

It is common for countries that adopt the GST or VAT (value-added tax) regime to prescribe selected financial services as exempt supplies. However, the experience of these countries reveal that the subject has resulted in great deal of litigation, in particular for financial institutions which supply both taxable and exempt supplies. 

Currently, the exempt financial services in countries which adopt the GST/VAT include: the operation of current deposits or savings accounts; foreign exchange transactions; credit card and charge card operations; letter of credit; issue/allotment of debt security/equity; and provision of any loan, advance or credit.  

Bhupinder Singh

It is not always straight forward to determine whether the finance services are exempt supplies, for example, certain securities may yield interest whilst others dividends. Receipt of interest by shareholders is consideration for an exempt supply whilst dividend is out of scope supply as it does not represent consideration for supply of goods and services by the holder of the security. 

Another major problem is the apportionment of input tax credit as many financial institutions provide mixed supplies comprising taxable and exempt supplies.  

For example, one major difficulty in applying the general (supply of goods or services) principle to the financial sector is taxing interest charges. This is because interest includes elements which reflect the risk of the loan, the real cost of capital, the inflation rate and a charge for the service rendered.  

In principle, only the charge for the service rendered should be taxed but is never easy to isolate this element from the rest.  

Financial supplies that qualify to be treated as “international services” will be zero-rated.  

An example of international services would be services supplied to a person who does not have a business establishment in Malaysia, the services supplied are not in connection with land or goods in Malaysia and certain other conditions are satisfied.  

For example, financial services (not strictly of a financial nature such as rental of safe deposit boxes) provided by banks to non-residents for which a fee is payable should qualify as international services which are zero-rated. As such, the pricing of such services may not be affected by the introduction of GST. 

Under the GST regime, the financial institution would have to pay GST on the consumption of services or goods (e.g. purchases of equipment, services, rental, utility etc) that are used in making its supply of services.  

Such GST is commonly known as the input tax. Under the GST rules, the financial institutions will be able to claim back the input tax that it has incurred in the provision of taxable supplies i.e. supplies that are subject to standard rated or zero-rated. 

For input tax suffered by the financial institution that relates to the provision of exempt supply of services, it usually would not be possible to claim a deduction of the input tax against the output tax.  

For common expenses like rent, utilities, etc, it would be necessary to allocate the GST paid on such supply of services between the exempt and taxable services.  

Only the input tax applicable to the taxable services can be deducted or claimed as an offset against the output GST collected by the financial institutions.  

Since financial institutions make mainly exempt supplies (about 90% of income is derived from lending operations), a significant amount of the input tax incurred will have to be absorbed by them. The inability of financial institutions to claim part of the input GST suffered may increase their operational cost. 

The financial institutions will need to modify their computer systems to meet the GST requirements. Firstly, the systems must be capable of distinguishing the services that are exempt, taxable and out of scope of GST (e.g. inter branch transactions). This is to ensure that the appropriate amount of GST is charged or not charged on the provisions of such services.  

Additionally, the computer system must be able to compute the GST status (refund or payment) and to generate information on irrecoverable GST so that such costs can be recovered in the pricing of the products, Further, the computer system should be capable of generating the GST invoices to facilitate its registered customers in claiming back the GST that they have paid to the financial institutions. 

It is common for overseas banks operating in Malaysia to receive head office allocation of costs incurred in providing support services to the Malaysian operations. When this happens, the Malaysian operation will treat the supply of support services (received from overseas) as having been made to itself and would be required to account for the Malaysian GST on the value of the services allocated to it. 

Since the provision of support services by the parent is a service common to all supplies made by the bank, it would be necessary to allocate the input GST under the “reverse charge” mechanism between the taxable and exempt supplies. As such, the financial institutions would only be able to claim back a portion of the input tax suffered on the support services. 

Attention must be given to contract of services that will span throughout 2007. Usually, concessions such as waiver of GST for the initial years may be granted, subject to the merits of each case. 

Conclusion 

The inability to claim part of the input GST suffered by the financial institutions as well as the cost associated with the accounting for the GST and other compliance costs would be a big concern to the financial institutions in Malaysia.  

In view that the Malaysian GST law is yet to be finalised, the above common industry issues faced by the financial institutions must be analysed in advance to enable timely representations to be made to the tax authorities. 

 

  • The writer is executive director of Ernst & Young Tax Consultants Sdn Bhd.
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