ON Jan 1 Malaysia implemented a service tax on digital services provided by Foreign Service Providers (FSPs) to Malaysian consumers. This is a tax framework we have seen implemented in several countries in the region, with more likely to follow.
Australia and New Zealand have had a similar tax in force for over a year now, while Singapore launched their variant at the same time as Malaysia.
While originally styled as a “Netflix tax” on digital services acquired by individuals, the Malaysian framework goes slightly further than its regional counterparts by taxing digital services provided to individuals (B2C) and also digital services provided to businesses (B2B).
Furthermore, an additional amendment was made to the service tax legislation to tax digital services provided by local businesses and by extension those imported. While this levels the playing field, there may be some unintended consequences.
The B2B conundrum
When we look at other digital tax frameworks, the usual strategy is to tax digital services provided by FSPs to individuals and exclude those provided to businesses.
The most common way of drawing this distinction is for the legislation to allow an FSP not to tax a digital service if the consumer can provide a valid GST or VAT registration number for the country where the digital service is consumed.
In such systems, the B2B digital service would be captured as an imported service by the VAT/GST registrant.
Under the sales tax and service tax (SST) frameworks, it becomes significantly more difficult to discern between B2B and B2C transactions. The solution adopted is a pragmatic one; the FSP taxes both B2B and B2C sales.
At the consumer end, an exemption on imported service tax combined with an offset mechanism mitigate any potential double taxation of B2B transactions.
Digital or not digital?
While the exemption and offset mechanisms seek to eliminate areas of double (or multiple) taxation on the same service, the key question to consider is what exactly is a digital service?
Digital services are defined in the service tax legislation by three key parameters:
> The service is delivered or subscribed over the Internet or other electronic network;
> The service cannot be obtained without the use of information technology; and
> The delivery of the service is substantially automated.
On the surface, this definition seems sufficient to capture the services it targets. Video streaming, music streaming, cloud hosting and online gaming would all meet the above.
But when applied in a B2B context, further services come into the scope of the tax.
As an example, consider a multinational corporation that develops an automated online training platform in its head office in Australia.
The Australian company charges its Malaysian subsidiary RM600,000 per year to use the platform.
The online training platform meets the definition of digital services, and becomes taxable. As a result, the Australian company has to register for and charge digital service tax by virtue of one transaction with its Malaysian subsidiary.
If the Australian company did not register for the tax, the local subsidiary would be required to self account for service tax on the imported service.
Therefore, would it be more efficient from a business and an enforcement perspective to exempt the Australian head office from registration? At this time, the law does not allow for such an exemption.
Further issues arise with the inclusion of digital services as taxable services in the local legislation.
Consider a healthcare services provider that develops a chatbot for preliminary diagnosis. Patients can pay a fee to go online and be diagnosed by the chatbot.
In substance, this is a healthcare service which even under the GST the government went to great lengths not to tax. But because of the delivery mechanism it would fall within the definition of a digital service and be subject to 6% service tax.
So does the digital tax go beyond its remit?
The key issue is an apparent conflict in the definition of taxable digital services.
Under the conventional service tax, taxable services are defined by what they are. Professional services, advertising services, broadcasting and telecommunications are all examples of taxable services. But by focusing on how the service is delivered, the digital definition captures digitally delivered services regardless of their nature and the policy intent.
As noted above, the rules are similar in other territories, so this would not be a uniquely Malaysian problem.
However, arguably, the application of the digital definition beyond B2C transactions and the inclusion in the local legislation, provides the most significant issues.
In moving forward, the Royal Malaysian Customs Department, and the Finance Ministry should give due consideration to the intention of the tax, and produce clear guidance as to how the rules should be interpreted in the context of the policy intent.
Tim Simpson is PwC Malaysia tax director while Annie Thomas is PwC Malaysia tax senior manager. The views expressed here are the writers’ own.
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