How indirect tax reforms can help Malaysia achieve fiscal sustainability

Budget 2024 aims to transform Malaysia's economy, positioning it as a prominent player among Asian nations, and generating increased prosperity that will be fairly distributed to benefit the people.

In brief

• The government might explore strategies to expand its sources of fiscal revenue and review aspects of tax enforcement and administration.
• The upcoming rollout of the Luxury Goods Tax (LGT) represents a forward-thinking approach.

Prime Minister, Datuk Seri Anwar Ibrahim, who is also the Finance Minister, will table the 2024 Budget in Parliament on 13 October 2023. Themed "Madani Economy: Empowering the People", the 2024 Budget aims to restructure the economy to make Malaysia a leader among Asian economies and create enlarged wealth which will benefit the Rakyat  equitably. To achieve this, the Government has set various short-term and medium-term targets for the next ten years.

One of the key medium-term targets under the Madani Economy is to achieve fiscal sustainability with a fiscal deficit of 3%, or lower. To achieve this target, the 2024 Budget announcement may include certain tax measures to improve the country’s revenue collections, and proposals to mitigate leakages by improving fiscal governance and transparency. Nevertheless, changes to the current tax system will need to be balanced against the Government’s other objectives, including elevating the quality of life of the Rakyat, managing the cost of living and positioning Malaysia as a globally competitive investment destination.

As an option, the Government may consider a strategic reform of the current indirect tax landscape with a view to lead the country towards economic growth, and secure increased and more sustainable Government revenues. This may not necessarily require an immediate introduction of a new tax. Instead, a well-thought-out progressive tax policy as well as administrative changes can help expand and enhance the current tax system.

Enhancing the fiscal space by improving the current tax system

With the commitment to improve the fiscal position and achieve long-term sustainability for the country, the Government may look for ways to broaden its fiscal revenue base and relook at certain aspects of tax enforcement and administration. At present, among the Government’s efforts to improve tax collection include the Voluntary Disclosure Programme for both direct and indirect taxes, as well as introducing the implementation of e-invoicing in the country.

During the recent 12th Malaysia Plan (12MP) mid-term review, there were discussions on reintroducing the Goods and Services Tax (GST) to replace the current Sales Tax and Service Tax (SST). The Government is not ruling out the possible reintroduction of GST. However, before considering the reintroduction of GST in Malaysia, the Prime Minister emphasized that the Government should reduce the subsidies for the wealthy via a new “Targeted Subsidies” system, given that subsidy expenses are a key Government expenditure.  Further, the Rakyat's income must first be increased to a reasonable level before reinstating GST.

While the reintroduction of a multi-stage consumption tax system, such as the GST, may be assessed in the future, subject to certain conditions that need to be met, there may be other ways for the Government to introduce progressive tax policies. Specific to indirect tax, this can be done by enhancing the current SST system. One immediate measure could be to expand the scope under the existing SST legislation to cover additional goods and services.

At present, several goods are exempted from Sales Tax.  The Government could consider whether these goods should be subject to Sales Tax. The Government may also consider expediting the implementation of the Sales Tax on Low Value Goods (LVG), which was initially meant to be implemented on 1 January 2023 but was postponed to a later date yet to be announced.

In the case of Service Tax, which only applies to a number of prescribed services, an expansion of scope to cover new services would enable Government revenue to be increased. An initial area of focus could be on services which have inconsistent or to be inequitable tax treatments. For example, in the repair and maintenance services sector, Service Tax currently applies only to repair and maintenance services for motor vehicles, and not for repairs and maintenance of other goods. Overall, an in-depth study on the expansion of scope of the SST needs to be conducted to ensure that the SST system is progressive and equitable. Daily necessities should not be taxed and these measures must not impact the welfare of the Rakyat.

In the long term, like GST the Government may also consider an input tax credit mechanism to be put in place under the current SST regime. This will help address the issue of tax cascading, and consequently help to address the issue of rising prices in Malaysia. This approach may also reduce tax leakages by encouraging more taxpayers to register for SST.

An in-depth study on the feasibility and implications (including the impact on indirect tax collections) should be undertaken prior to implementing such measures.

Proposed taxation of luxury goods 

The impending implementation of the Luxury Goods Tax (LGT) on certain types of goods, is also a matter to look out for. This proposed tax was announced in the re-tabled 2023 Budget in February this year, with a view to implement a progressive approach of collecting more tax from higher-income earners or from people who have the means to pay.  This is in line with the Government’s position to not yet implement a wide-based consumption tax like the GST, which is viewed as a tax that may impact more segments of the Rakyat in these challenging times.

It was mentioned in the recent 2024 Budget dialogue session organised by the Government that the Government is still conducting dialogue sessions with various stakeholders on the details and mechanisms of such tax, which includes the threshold value of the luxury goods on which LGT will be imposed. For LGT to become a progressive form of tax, there are few areas for the Government to consider.
 

In this respect, the type of goods that will be covered and the corresponding value thresholds for the goods to be considered as “luxury goods” must be clearly defined. At the outset, streamlining the classification and categorization of luxury goods based on the existing and internationally recognised Harmonized System (HS) Codes can be considered. This is a practice that is also adopted by the Royal Malaysian Customs Department for other types of indirect taxes.

In addition, the Government should have a process in place to periodically review the luxury goods tax rules,  as certain goods may be added to or removed from the luxury goods category or certain value thresholds may need to be updated, after taking into account  changes in  consumption patterns and needs, as well as inflation.

The manner of imposing the said tax is also a question at this juncture – i.e., will it be charged only for Business-to-Consumer (B2C) transactions, or will Business-to-Business (B2B) sales also be impacted? Regardless of the approach, measures should be taken to ensure that the imposition of such a tax would not cause unnecessary price increases or a tax-cascading impact, whilst also ensuring that potential abuses are anticipated and addressed.

If the LGT is to be imposed on both B2B and B2C transactions impacting several stages of the supply chain, an input tax credit mechanism can be considered on the LGT charged on luxury goods  meant for onward sales to end consumers. In this way, the LGT will only be a cost to the end consumer and risk of tax-cascading will be mitigated.

It goes without saying that in implementing new tax measures, there must be a balance between increasing tax revenue collections, attracting investments into the country and safeguarding the Rakyat’s welfare. The Government will also need to consider the impact on Small and Medium Enterprises (SMEs) and ensure that these businesses will not be adversely impacted by the change in the tax landscape and that the cost of compliance will not be prohibitive.

At the end of the day, any manner or form of strategic indirect tax reform to achieve the intended goal – be it a new tax, or an enhancement to the current tax system – should be carefully evaluated, with sufficient prior consultation with the relevant stakeholders to ensure its effectiveness and sustainability, while being viewed positively and being well-received by the public and business community.