GOODS and Service Tax (GST) is tax on what is spent and not on what is earned. Earlier on March 30, 2010, Prime Minister Datuk Seri Najib Tun Razak unveiled the New Economy Model (NEM) and it recognises that a wider tax base is an important part of reforms, where the introduction of GST is a key component. It was reported that a more diversified tax base is needed to compensate for an expected future reduction in the share of revenue from oil and gas.
Najib will make his Budget 2014 speech on Oct 25 and the long overdue GST is likely to be a major part of a package of tax reforms. Malaysia’s household debt to GDP was 83% in mid-2013 compared with 70% in 2009. Policymakers and tax analysts too consider its introduction inevitable, particularly given the paradigm shift in tax policies worldwide in favour of indirect taxes. More than 160 countries worldwide have already introduced GST (known as VAT in European countries) and more than 90% of countries have some form of GST exposure.
Goods and Services Tax Bill
On Dec 16, 2009, a Goods and Services Tax Bill was tabled in Parliament but it was subsequently withdrawn for reassessment. The GST Bill sought to impose a tax on goods and services but essential items would either be zero-rated or exempted. To protect small businesses, the Finance Ministry has recommended a threshold of RM500,000 in annual turnover. This would imply businesses below that threshold need not register nor do they need to collect GST. Once an announcement is made to introduce GST, actual implementation would be subject to a 12- to 15-month long preparation period for businesses to familiarise themselves with the new accounting procedures.
Weaknesses of existing system
The existing sales tax, introduced in 1972, is a single stage tax on the manufacturing of goods and the importation of manufactured goods. Exemption from the tax is dependent on the turnover (RM100,000) of licensed manufacturers and the type of manufacturing activity. Despite a complicated procedure for claiming relief of the tax in respect of business-to-business transactions, the tax has a cascading effect, which means that, to a certain extent, the tax incurred by manufacturers is taxed again at subsequent stages of the manufacturing process. The service tax was introduced in 1975 and it is also found to have an arbitrary effect on consumer prices.
Service tax only applies to a narrow set of defined activities classified as “taxable services” whose value has exceeded (exceptions apply) a certain annual threshold. Liability for service tax is therefore based on a combination of business characteristics and the types of services. The turnover threshold does not apply to numerous professional services. The service tax does not only have a cascading effect, it also accumulates with sales tax.
Impact on consumer prices
The introduction of GST will have an impact on consumer prices and, therefore, on real income. The extent of the tax burden on various categories of expenditure will depend on the GST rate, threshold limit as well as on the scope of the exemptions or application of zero rating.
In 2012, sales tax yielded RM9.2bil while service tax yielded RM6.2bil. Both these taxes account for 7.7% of Federal Government taxes. In the same year, indirect taxes (RM33.1bil) merely accounted for about 15.8% of federal taxes while direct taxes accounted for RM124.8bil or 59.7% and non-tax revenue was RM51.3bil or 24.5%.
An increase in revenue collection from the switch to GST from existing sales tax and service tax will come from enforcing tax collection across a broader chain of production and distribution of goods and services.
Attraction of GST
The single most attraction of GST is it being seen as a neutral tax that would provide substantial revenue to the Government without lowering the effectiveness or efficiency of the market system in allocating capital, land and labour. It is a means of increasing the government tax base by reaching out to a broader group of people, namely consumers. The GST system has a self-policing mechanism due to in-built cross-checking features which would improve tax compliance. Taxpayers (i.e. registered persons) are also compelled to maintain orderly accounts and hence there is less scope for tax evasion.
GST in Singapore
In 1994, the Singapore government introduced GST at a low rate of 3% and with a high threshold limit of S$1mil. Hence, only large business enterprises were needed to register to collect GST. However, very minimal goods and services were either zero-rated or exempted, hence lowering tax leakages and improving efficiency in the collection of revenue. The GST rates were gradually increased over the years to 7% from July 2007 onwards.
During this period, corporate tax rate in Singapore was lowered from 30% in 1993 to 27% in 1994; and further lowered over the years to 22% in 2003; 20% in 2005; 18% in 2008 and 17% from 2010. To help companies cope with rising business costs, the Finance Minister announced in Budget 2013 that, for the years of assessment 2013, 2014 and 2015, companies will receive a 30% corporate tax rebate that is subject to a cap of S$30,000 per year.
Salient features of GST
If GST is implemented, the tax would be charged on any taxable supply of goods or services made by a taxable person; and on the importation of goods or services. The word “business” includes any trade, commerce, profession, vocation or any other similar activity.
The generic term GST covers a set of broad-based ad valorem taxes that share two common features, namely:
(i) The tax is collected at every stage of the production process, and
(ii) The amount collected at each stage is based on the value added at that stage.
The GST is supposedly a regressive tax but there are ways to mitigate the tax burden faced by middle and lower income groups as well as small businesses. It is likely that the proposed GST charged on a broad range of taxable supplies is at the standard tax rate of 5%, hence revenue from GST would only increase modestly. Essential supplies of over 40 items would be either zero-rated or exempted and such a move would be favourable to the broader community, particularly the lower income groups.
Zero-rated goods and services are goods that have no tax charged on consumers. This means that the final consumer will literally pay GST at a rate of zero per cent. When goods or services are zero-rated, the firm can still claim credits for all inputs but is required to charge output tax only on non-zero rated supplies, hence it could receive a net refund.
Likely zero-rated supplies are exports of goods, international services, agriculture produce, essential foodstuff (example: rice, sugar, table salt, plain flour and cooking oil), livestock supplies and fish. It is likely that a pre-determined units of electricity to domestic users and limited cubic metres of water to domestic users would be zero-rated.
Exempted supplies are those items that “miss out” on one or more stages of the GST assessment process. In Australia, exempted supply are referred to as “input taxed supply”. Producers of exempted supplies do not receive a credit for the GST incorporated in their input costs and are not charged tax on their exempted supplies. The effect is that the commodity is taxed at a lower effective rate. For example, if a firm purchases inputs costing A$110, GST-inclusive (at say 10%) and makes exempted supplies of RM160, the only tax on final sales is the (non-credited) A$10 included in its purchases, so the effective rate is (A$10/A$160) = 1/16 of the gross price (7%).
Exemptions, however, introduce economic inefficiencies and reduce the revenue base, but the effects will not be as severe as zero-rating because the exempted commodities still bear some GST. The effective rate is proportional to the share of value-added at the relevant stage in the total value of the commodity.
Critical items likely to be treated as exempted supplies are financial services, private health and education, domestic transportation of passengers, sales and lease of residential property, and land for public use. The GST credit offset mechanism cannot be used to tax financial services on a basis consistent to other goods and services. This is due to the absence of explicit fees for financial services; the value of input supplied by financial institutions is a spread that may be only a few basis points in the total charge to a customer.
Distributional effect of GST
The author investigated the distributive effects of a comprehensive GST on prices of a broad group of commodities and services in Malaysia. Base data was compiled from the Household Expenditure Survey (HES), which collates information on levels and trends of consumption expenditure by households on a comprehensive range of goods and services. The 11-monthly expenditure classes (categories) vary from below RM500 (Class 1) to above RM5,000 (Class 11). A simulation model was developed to determine the effects of the GST on households. Four GST rates, namely 3, 5, 7 and 10 percentile points were considered in the simulation exercise.
The findings of this study suggest that the GST is not necessarily a regressive tax and it is even found to be fairly progressive.
The distributional effect of GST in Malaysia should not be examined in isolation but viewed within the context of a fiscal system comprising tax and government expenditure programmes. A tax is seen as regressive when it would impose a proportionately higher tax burden on lower income earners than higher income earners. The mild regressive aspects of the indirect tax could be overcome with financial assistance programmes, imposing graduated excise duties on non-essentials and prudent use of a GST coupon system to support the lower income groups.
Dollar for dollar reimbursement
It is generally felt that GST implementation is more urgent now due to rising GDP-debt ratio, low earnings from the petroleum, gas and commodity sectors as well as the need to narrow the budget deficit. In a GST environment, greater efforts are needed to boost productivity and promote innovation. In this regard, a dollar for dollar reimbursement should be given for GST-related expenditure on R&D activities, cost of purchase of new accounting software and expenses related to re-training staff. A double deduction should also be given under the Income Tax Act 1967 for all GST related book-keeping expenses which the Malaysian Inland Revenue Board would find useful for tax audit verification.
The GST when implemented in Malaysia can be seen as a reformatory move to further promote efficiency of the tax administration.
> Jeyapalan Kasipillai is a professor and deputy head of school of business, Monash University Malaysia. He is also an adjunct senior research fellow, Monash University Melbourne.