Business

Monday October 12, 2009

Service tax – paradigm shift needed to push for growth of services sector

On every Monday and Wednesday leading up to Budget 2010 announcement, PricewaterhouseCoopers will discuss tax issues to help Malaysia achieve its objective of becoming a high-income society.


THE renewed focus on the services sector as the key driver of the nation’s economic engine underscores the need for a consumption tax that would facilitate its development into a strong and resilient economy.

As transactions in the services sector become far more varied and complex, the introduction of the Goods and Services Tax (GST) to replace the existing consumption tax on services – service tax and sales tax – becomes even more imperative.

When the 5% service tax was introduced in the 1970s, the Government, while recognising that the services sector was of growing importance and would be a potential source of revenue, nevertheless limited the tax to only certain services consumed by tourists, such as hotel services.

Since then, the scope of service tax has slowly expanded to cover transactions which include certain professional and consultancy services as well as telecommunications and management services. Unfortunately, the fundamental structure of service tax law did not change in tandem with the complexity of the services.

As it stands, there are key inefficiencies of service tax which inhibit the services sector:

● No input tax credit leads to unnecessary tax cost to businesses: The “single-stage” of service tax effectively means that businesses which receive taxable services from suppliers will incur the tax as an additional cost. And if the business recipients are themselves suppliers of taxable services, they will charge service tax on the value of their taxable services.

Therefore, tax is imposed on tax, creating a cascading effect of tax which unnecessarily escalates the cost to businesses.

On the other hand, a multi-stage consumption tax like the GST would allow an input tax credit to be given to each supplier in the chain for the GST paid by the supplier on business purchases. This prevents the GST on business inputs being a cost to the suppliers and the tax from cascading.

● Taxation of “export services” impairs competitiveness in the global market: In a borderless world, the intangible nature of services facilitated their seamless provision across countries.

In 1996, the Service Tax Act 1975 (the Act) was amended to enact a definition of “exported taxable service” that would not be subjected to service tax. This is based on the principal test that the customers would be outside Malaysia.

This was done with the intention to promote the export of taxable services by domestic suppliers, giving them a competitive boost in the global marketplace.

However, in 2003, this definition was abolished when the Act was amended, with a view that it would be dealt with under amendments to the service tax regulations. Unfortunately, the amended service tax regulations did not re-enact it, resulting in service tax being technically chargeable on taxable services provided to customers outside Malaysia.

Although in practice Customs did initially perpetuate “exported taxable service” despite its abolition, in recent times Customs has advocated a strict implementation of the regulations, thereby impairing the competitiveness of Malaysian suppliers in an increasingly globalised world.

In comparison, a GST system will invariably not tax export services based on the principal test of “customer located overseas”, in order to promote exports.

● Unfair playing field with imported taxable services which are not taxed: As a corollary to the export of taxable services from Malaysia, the import of taxable services is an equally, if not more prevalent, occurrence, in view of the greater need for foreign service expertise in a developing country such as ours.

Service tax is only chargeable by taxable persons who carry on business in Malaysia. It is not imposed on imported taxable services – taxable services “imported” by customers in Malaysia from suppliers who carry on business outside of Malaysia.

Therefore, due to the service tax factor, a domestic supplier of taxable services would be pricing itself out in its own backyard, vis-à-vis the same services that are imported from a foreign supplier, which would not be taxable.

In a GST framework, however, GST would be imposed on imported services, thus levelling the playing field for local and foreign suppliers.

This demonstrates that nothing short of a paradigm shift is needed to overcome the structural inefficiencies of service tax.

It cannot be overemphasised that a GST system removes key service tax weaknesses, thereby setting the stage to catalyse the services sector as the engine of growth.

● Sitartha Raja Kumaran Rasiah is executive director of PricewaterhouseCoopers Taxation Services Sdn Bhd.

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