Insight - The impact of introducing capital gains tax in M’sia

The director general of the Inland Revenue Board, Tan Sri Sabin Samitah, recently suggested the implementation of CGT to shore up the country’s income. According to Sabin, Malaysia’s existing tax base was rather narrow and relied heavily on corporate and personal income taxes, as well as petroleum-related taxes.

CAPITAL gains tax (CGT) is imposed on profits realised on the sale of an asset. The most common capital gains are from the sale of stocks, bonds, precious metals, real estate, and property. For that matter, antiques, art collections and other assets that increase in value could also be subject to CGT.

Presently, Malaysia does not impose CGT on the disposal of investments or capital assets other than real property gains tax (RPGT), which is levied on chargeable gains derived from the disposal of real property or shares in a real property company in Malaysia.

The chief executive officer of the Inland Revenue Board, Datuk Sri Dr Sabin Samitah, (pic below) recently suggested the implementation of CGT to shore up the country’s income. According to Sabin, Malaysia’s existing tax base was rather narrow and relied heavily on corporate and personal income taxes, as well as petroleum-related taxes.

Besides helping to widen the country’s tax base, he said the CGT could be a good tool to address income inequality in the system, as individuals in higher-income brackets are more likely to have capital income.

Further, a gradual reduction of the corporate tax rate to 20% would require the need to widen the tax base to compensate for the loss of revenue as a reduction of 1% in the corporate income tax rate would result in more than RM2.6bil worth of revenue loss to the government.

At 12.5% of gross domestic product (GDP), Malaysia’s tax base is among the lowest in the world. By comparison, the average of the Organisation for Economic Cooperation and Development countries is about 15%, while the comparable economies by GDP per capita, Turkey and South Africa, record tax collections of 17% and 26% respectively.

There has been an interesting debate on the introduction of CGT in Malaysia of late, with economists and analysts voicing concerns that the imposition of CGT on the transaction of listed shares could draw negative reactions from investors, and significantly reduce Malaysia’s attractiveness as a destination of equity investment compared to countries with no such taxes such as Singapore, Hong Kong, and the Philippines.

Investors evaluate risks when investing capital and taxes on capital can potentially drive them away as the taxes create an additional risk burden.

It would cost more in transaction fees to investors and can have a substantial impact on the supply of capital stock and the level of entrepreneurship.

It is interesting to note that RPGT is expected to contribute RM1.9bil, or 0.8%, to government revenue in 2021. In 2020, RPGT was expected to contribute RM1.6bil, or 0.7%, while in 2019, it was RM1.8bil, or 0.7%, which is insignificant.

The introduction of CGT on the disposal of other assets would be unlikely to contribute significantly to the coffers of the government. On the contrary, there could be capital flight to other countries which would be counter-productive.

In reality, CGT is probably the least of all factors under consideration when it comes to investment decisions. What would matter more to fund managers is the health of the economy, the fundamentals of the target counters and the quality of their earnings.

The Kuala Lumpur benchmark index gained 3.5% last year in comparison to Vietnam’s VNINDEX, which rose 14% despite having a tax on gains from the disposal of securities.

The lacklustre performance is not due to the existence of a tax or otherwise, but because more than 50% of all Bursa Malaysia counters are penny stocks.

In the final analysis, it is the strength of the real economy that gives vibrancy to the financial market, not the absence of a CGT. A conducive investment environment and the repackaging of incentives towards specific investors will help attract foreign direct investment.

In any case, if CGT is introduced, there should be a holding period as well as profit threshold for purposes of taxing the gains.

While short-term investors and speculators pay their fair share of tax on gains attained, long-term investors should preferably not be badly impacted so that Malaysia remains an attractive investment location.

It is quite possible for some capital gains taxes to boost risk taking. In order to achieve this, the government would need to not only recognise capital gains but give a deduction for losses as well.

This could perhaps incentivise investors to take risks. Basically, if the returns on safe assets were zero, and the government taxed gains and subsidised losses at the same rate, then capital taxation could encourage risk taking; and the government would in effect, be a silent partner.

The introduction of CGT requires careful analysis and study on the impact on the Malaysian economy as a whole and the timing needs to impeccable to achieve its objectives.

In the current economic environment, Malaysia cannot afford the risk of capital flight and with many investors facing potential losses, there would probably be nothing to gain and everything to lose in the short to medium term.

Harvindar SIngh is managing partner of Harvey & Associates. The views expressed here are his own.

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