In yesterday’s article we saw how inefficient the goods and services tax (GST) was, and how it increased the tax burden on the consumers as well as businesses.
We have also identified a few major shortcomings of the existing sales and service tax (SST2.0). In this article, we will propose how to overcome each of them, and explain the benefits of the tweaked SST.Eliminate cascading effect of taxes
To eliminate a tax on tax, the sales tax and service tax should not be implemented under two separate Acts in separate silos.
They should be combined so that any company with a sales tax or service tax registration number need not charge sales tax or service tax to each other.
Datuk T. Subromaniam, the former director-general of Customs, in informal discussions with me in 2019, was also thinking along the same lines.
He even came up with a name - a Harmonised Sales and Service Tax (HSST). We didn’t come to a decision as to whether to call it HSST or HST. For now, let’s just name it HSST. It should function like a GST without the cumbersome process of booking an input tax, accounting for it as a credit against output tax, and remitting the difference to (or sometimes claiming a refund from) the government.
The GST is a multi-stage tax, with each company imposing a 6% output tax against a 6% input tax and so on along the entire value-chain. The SST, on the other hand, is a single-stage tax levied at factory gates – at a higher rate of 10% – but would not involve further sales tax further down the value-chain.
Therefore, to avoid the complex intermediate input tax accounting and payments under GST by so many; under HSST, service or sales tax is only imposed when that product or service is sold to the final consumer or to a business with no tax registration number and so is imposed only once.
In this way, a manufacturer can buy all his inputs free of sales tax or receive invoices for consultancy fees, legal fees, advertising charges, freight forwarding fees free of service tax just by quoting its sales tax number.
A hotel that charges a service tax to its customers would now be able to buy all its inputs free of sales or service tax by quoting its service tax number, again avoiding the tax-on-tax effect, just like under GST. A beer manufacturer will sell beer without sales tax to the hotel which will charge service tax to its customer on that can of beer so tax is only paid once, avoiding tax on tax, again just like in the previous GST regime.
For smaller restaurants without a service tax number, the manufacturer must charge sales tax to them and they in turn will incorporate the sales tax into their prices as they cannot charge any service tax to their customers. In such cases, government revenue is collected at the manufacturer level, rather than at the restaurant level.
A garment manufacturer will just issue an invoice for 10,000 shirts and charge 10% sales tax once to a department store chain. The department store chain that has no sales nor service tax number, will add on its margin and sell the 10,000 shirts to end-consumers without charging any further taxes. Customs department need audit only that one invoice rather than 10,000 separate receipts.
Consultants like architects, lawyers and accountants will not charge each other or manufacturers service tax but only to final consumers without a sales or service tax number. This does not mean that the government does not receive anything from the activities of the consultants; when they service the manufacturers their fees become a cost for the manufacturers, and the HSST is eventually charged on the manufacturers’ output which had included the fees (without any service tax) of the consultants.
Similarly the products that service providers buy are built into the final cost of services that they levy the service tax on.
Eliminate problem of delays in input tax refundsUnder the HSST regime, manufacturing companies need not pay for input taxes and therefore the problem of delayed refund of input taxes, a major problem with GST, no longer arise. It will also eliminate fraud due to over-claiming of input taxes either in the form of credits or refunds.
Avoid complexities of sales tax-exemptionsAs pointed out earlier, for social equity reasons, government has exempted certain products and services from sales and service tax. This practice of exemption has been used in many countries whether under a GST or SST regime. Unfortunately, whilst exemption is granted to the finished product or service, exemption is not extended to the inputs that go into that product or service. This causes an increase in the final price.
In addition, if a manufacturer produces both taxable and non-taxable products, the inventory of every item in the bills of materials has to be segregated to track what had gone into which of those two categories. This leads to inefficiencies, and complexities in Customs audits.
The solution proposed is a policy change whereby if a final product or service is tax-exempt, then the exemption should be extended backwards to the inputs i.e the inputs should also be tax-exempt. This may result in a slight reduction in tax revenue but this is made up by the increase in tax efficiency all round, eliminates tax on tax and any tax shortfall could be made up in future by a slight increase of the general tax rate.
This policy will have many benefits. Tax-exempt service providers like the education and health service providers would have lower costs of inputs and consumers would be able to immediately benefit from lower prices – and further fulfil the objective of the original intention of providing such services tax-free.
For manufacturers, it levels the playing field against tax-exempt imported products and immensely simplifies the procurement and recording of raw materials and components. All inputs for manufacture can then be purchased free of sales tax and the inputs need no longer be segregated and tracked whether they were used for the manufacture of taxable, tax-exempted or export goods.
Facilitate and Simplify Customs Enforcement Customs enforcement resources will be freed from monitoring and analysing stocks and inputs to focusing fully on the output stage of manufacturers and service providers. The audit process will then concentrate on output invoices of taxable goods and services issued by the companies in the following manner:
> If the invoices do not show a sales or service tax registration number of the customer, then sales or service tax must be levied and remitted to the government.
> If the invoices show a sales or service tax registration number of the customer no tax would be levied. Spot checks to verify that the customer exists and have actually been invoiced for goods/services with that particular invoice number will make manufacturers or service providers fall in line. The spot checks on that customer must show that it in turn had output invoices of its own on which it had charged output HSST, to flush out companies set up just to buy goods or services free of HSST for friends and families. Repeated discrepancies would attract severe penalties.
Specialised Traders to Be Considered as “Deemed Manufacturers”There are importing and trading companies that supply manufacturers. Unlike the GST system, manufacturers faced difficulties in claiming refund for the sales tax charged on goods supplied by these trading companies who would have paid sales taxes at time of importation. To get around this conundrum, these trading companies should be allowed to apply for a sales tax number and be registered as a “deemed manufacturer” and can then import components and materials free of sales tax and supply the goods without tax to registered manufacturers.
Conversely, a trading company that specialises in exports can also get a “deemed manufacturer” sales tax number so that a manufacturer can supply these specialised export trading companies free of sales tax. When these trading companies export those products, they can do so without paying any sales tax – sales tax-free end to end. But if they sell those products in the domestic market to customers without a sales tax number then they have to charge sales tax.
A Comprehensive Approach to Defining Manufacturing Inputs
The principle mentioned above that all inputs should be free of sales tax for any company with a sales tax or service tax number will simplify the HSST system. It should not be a case of chasing sales tax revenue early in the value-chain by levying input sales tax because it appears obvious, but instead to allow all inputs to accumulate without taxes, and only tax at the output stage where all costs are priced into the product to be taxed. Letting all registered entities buy their inputs free of sales or service tax does not mean tax is not collected but it is only delayed till the product or service is ready for sale to consumers. Imagine the simplification that results – there is no need to monitor or segregate inputs.
Above is a chart summarizing the output taxes of the HSST with all inputs exempted from tax for all registered manufacturers and service providers. The control points are greatly reduced and enforcement efforts can be focussed only on the few output points (in red) where the final output sales/service tax is levied.
The HSST As A Viable Alternative to GST
The proposed HSST can be implemented using the current sales tax rate of 10% and service tax rate of 6%. However in the future, after due study of the relative amounts of sales or service tax collected, full harmonisation may be considered by using a single HSST rate for goods and services, but this can be considered at a later stage.
Like all tax systems, HSST will not be perfect. And like the others it risk leakages through fraud and under-reporting. The solution lies, as usual, in sample auditing, and in including heavy penalties for defaulters and fraudsters. However, I believe the benefits and advantages of the HSST far outweigh its faults and disadvantages.
The HSST will be far more tax-efficient and involve only the major sectors of the economy collecting RM28bil compared to the RM35bil under the GST but only involving 80,000, not 480,000 enterprises under the GST. The HSST follows the classic 80:20 rule – where 80% of the tax revenue is collected from only 20% of the business enterprises in the country and thereby eliminating the non-productive cost of compliance of RM19bil imposed on the economy. As the economy grows, tax revenue will increase accordingly. The merits and simplicity of the HSST as enumerated in this and yesterday’s article may indeed serve as a good and practical alternative to GST.
Tan Sri Yong was a former President of FMM, and has served on the boards of Bank Negara, EPF, Mida. He was co-chair of Pemudah and was a member of the Economic Council. The views expressed are the writer’s own.
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