The pandemic has put a dent in the coffers of governments around the world. Closer to home, we saw Malaysia implement eight economic stimulus and aid packages worth RM530 billion to tackle the health crisis. With an ambitious target of reaching a budget deficit of 3% to 3.5% of GDP by 2025, this puts pressure on the government to find ways to increase its tax collection to continue to finance such expenses.
Are everyone paying their fair share of taxes?
The 2020 Fiscal Outlook and Federal Government Revenue Estimates Report (FOR) found that at the end of 2017, 62.4% of the 1,251,190 businesses were registered with the Inland Revenue Board (IRB), but only 7 , 8% were subject to tax. At the same time, only 16.5% of the 15 million employees pay personal income tax.
The underground economy is one of the culprits. In 2019, Malaysia’s underground economy accounted for 18.2% of GDP, or nearly 50% of the total stimulus packages the government had to initiate to deal with the impact of Covid-19.
The numbers speak for themselves. FOR recognizes the need to tackle tax evasion and under-reporting of income, which undermines the self-assessment system as well as public confidence in the overall tax system. The existence of hidden, informal and “hard to tax” sectors places an unfair burden on taxpayers.
Digitization of tax administration and tax returns is an important consideration to achieve better tax compliance and better revenue collection. This is based on the premise that adopting the technology will cast a wider net to capture those who are required not only to pay taxes, but also to pay the right amount.
In order to simplify tax compliance and tax audits as well as reduce tax evasion and fraud, the Organization for Economic Co-operation and Development (OECD) has introduced an international standard for the exchange of data in an electronic format named Standard control file for tax purposes (commonly known as SAF -T) between organizations and local tax authorities. The SAF-T is designed to enable tax authorities to conduct inspections more effectively and efficiently.
SAF-T has been widely adopted in countries such as Portugal, Hungary, Poland, Norway, Lithuania, Luxembourg and Austria. Non-OECD countries have also introduced similar approaches.
In Malaysia, an online platform for electronically submitting tax spreadsheets, known as the Malaysian Income Tax Reporting System (MITRS), was introduced. This paved the way for the digitization and standardization of tax returns and the exchange of information electronically, replacing paper returns.
MITRS is implemented in stages, starting September 1, 2020, starting with companies that are subject to tax audits or investigations. Currently, MITRS is not mandatory. Therefore, the establishment of a roadmap towards mandatory adoption of the system would improve the efficiency of tax audit processes and the identification of tax leaks.
The OECD report “Technological Tools to Combat Tax Evasion and Tax Evasion” advocates the adoption of technology to combat tax evasion. Electronic invoicing has been touted as an effective mechanism to combat incidents such as false invoicing, which seeks to over-report deductions and camouflage non-deductible expenses as legitimate deductions.
Electronic invoicing has been implemented in countries such as Argentina, Brazil, Colombia, Costa Rica, Ecuador, Mexico, Italy, Indonesia, South Korea and China. Italy was the first EU member state to introduce mandatory B2B (business-to-business) electronic invoicing as of January 1, 2019. The Italian model requires electronic invoices to be issued in a specific format and exchanged through the Sistema di Interscambio platform (managed by the Italian Revenue Agency), allowing the tax administration to obtain real-time information and monitor compliance. The State Tax Administration of China has an electronic value-added tax (VAT) invoice management system, in which all special VAT invoices must be issued and tracked by the system. Vietnam and the Philippines are catching up and will make e-invoicing mandatory in 2022.
Some of the more developed countries have implemented electronic invoicing, combined with real-time reporting and reporting of tax returns and accounting transactions on the basis of SAF-T.
Malaysia should learn from these international developments and seriously consider adopting an electronic invoice management system integrated with government systems. The use of digital tools makes it easier to detect fraudulent transactions, improves the efficiency of tax audits and attracts more businesses to the formal economy. A gradual implementation, starting with B2B transactions, can be considered.
Let’s make it simple
The simpler the tax system, the greater the desire to comply with our tax laws, especially if we want to encourage small businesses to become part of our tax system. Advances in technology have led more and more people to venture into the sharing or gig economy, and this could be the future trend in employment. A downward trend in traditional salaried employment would hamper personal tax collection and the way forward is to seek a simplified tax compliance model that would encourage sharing economy taxpayers to report their income accordingly.
In Malaysia, companies are subject to the same tax obligations regardless of their size. The only difference is the lower tax rate for small and medium businesses. With respect to statutory audits, the Companies Act 2016 has relaxed the requirements for preparing audited financial statements for small businesses that fall within certain parameters. One of the reasons is to help businesses reduce compliance costs. We should provide a different set of small business tax filing requirements. A presumption tax model can be considered for this group of taxpayers. In India, small businesses that meet certain income thresholds can opt for the flat tax regime, where eligible taxpayers do not need to keep books of account but report 8% of gross receipts as taxable income. To encourage companies to go digital, the rate is reduced to 6% of gross revenue.
Malaysia’s tax-to-GDP ratio is relatively low compared to its peers in Asia. With a tax-to-GDP ratio of 12.4% in 2019, it was below the Asia-Pacific average of 21% and below the OECD average of 33.8%. From 2007 to 2019, Malaysia’s tax-to-GDP ratio declined by 2.4 percentage points. Yet the country relies heavily on taxes to finance its spending. The 2021 budget predicted that 73.6% of total government revenue would come from taxes (direct and indirect taxes combined). As the government considers introducing new taxes to broaden its tax base, it is worth reviewing its current tax framework and accelerating digital adoption to close the gap and curb tax leakage.
Sim Kwang Gek is the fiscal leader of Deloitte Malaysia