Sunday 22 December 2013

GST - Part 2: Generally Superior, Theoretically

The Goods and Services Tax to be implemented by 1 April 2015 has been the talk of the town, at least it had been until the unending swarm of rate hikes shifted our attention. Nonetheless, there is still a lot left under the carpet. The government has been airing various misleading advertisements about GST and word from social media has been equally misleading albeit spun in the opposite direction. To do my part to clear any confusion regarding GST and to capitalise on my prior research on GST, I shall write a series of articles on the subject.

Part 2 - Is GST a good tax system and is the government ready for it?

Is GST a good tax system?

At any point where you have no idea what the hell I'm talking about because you're unsure how GST works, scroll up and click here.

GST is an excellent tax system. If otherwise, it would not be implemented in 160 countries around the world. It is without a shred of doubt better than the current system in Malaysia whereby there are two taxes - Sales Tax and Services Tax in terms of efficiency.

Before any comparison can be done, we need some explanation on how the taxes work.

Sales Tax is levied upon any person (individual or company) who engages in the manufacturing of taxable goods in the course of business[1]. Manufacturers with an annual turnover of less than RM100,000 of taxable goods can apply to be exempt from Sales Tax[2]. As it is only charged to manufacturers, it is a one stage tax, as compared to GST, which is a multistage tax levied on every business in the supply chain. Sales Tax rate is generally 10% but is 5% for basic products, 20% for others while fuels have specific tax rates[3].

The inefficiency of the Sales Tax lies in the fact that it is a one stage tax. Manufacturers which are required to pay Sales Tax can easily set up companies to sell their products to at rock bottom prices. As a result, they are taxed less and the companies which bought the products are free to sell at market prices, without paying Sales Tax. With GST, there is no escape from the taxman as goods and services are taxed at every stage. The companies set up by the manufacturers would be taxed anyway when they sell their products, eliminating this trick from the book. This is why GST is more efficient, as it is more difficult to avoid taxation.

Services Tax is 6% which is the same rate as GST so no changes there other than the turnover threshold which is up to RM500,000 for GST from a range of RM150,000 to RM500,000 for Services Tax[4]. Taken at face value there should be no gain in efficiency in the switch. That being said, the gain in efficiency lies in the fact that there will be one tax system - GST as compared to the current two - Sales and Services Tax.

All in all, GST is a more efficient tax as it is harder to avoid and eliminates the need for two tax systems.

Is the government ready for it?

It is pretty much established that it in theory, GST is superior tax system as compared to the current system. It is also excellent for our government in terms of revenue as it affects more businesses than before and is projected by the Royal Malaysian Customs to rake in an additional RM5 – 6 billion per annum[5]. However, is the government ready for it?

I don’t think so. We know that a system is only as good as its execution. Any system, no matter how theoretically sound it is, means nothing if it’s poorly executed. That is the concern I have for the implementation of GST in Malaysia. GST, as much as it is efficient, is more complex than the previous tax systems. The complexities are not only present in the administration of the tax but also in its legal side. Bear with me and let me explain how.

Administration

The first issue I have with the administration of GST is the workload. Let us look at it using simple mathematics. Currently, there are about 20,000 manufacturers with Sales Tax licences, meaning they have to pay the taxes. Once GST is implemented, the number of businesses affected will be north of 200,000, tenfold of what it was before[6].

It doesn’t end there. Sales Tax involves little to no refunds, except in the cases of erroneous refunds, overcharging, or with approval from the Finance Minister or the Director General of Customs and Excise[7]. We can assume that most taxes go one way, from manufacturer to customs, with the few exceptions. If it goes the other way, it would mean that our customs is doing a poor job to begin with. With GST, taxes go both ways in the form of input and output taxes as shown in my previous article


Using my previous example, with 3 businesses in the supply chain, under the Sales Tax only the manufacturer would be taxed. That is it. Under GST the same supply chain would have tax collected from 3 businesses taxed and 2 businesses getting deductions. Bear in mind that this is possibly the simplest supply chain. In the real world, manufacturers would be procuring raw material from other manufacturers. There could also be more than one wholesaler. Most goods actually go through multiple distributors in a supply chain. Every time goods change hands, two tax transactions occur. As such, the administrative workload would be multiplied by factors way beyond ten.

As far as I know, Customs has no plans on mass recruitment for the implementation of GST. It would seem that it is relying more on systems than personnel for the smooth running of GST. However, even the best systems need to be monitored. With the much larger number of transactions once GST is implemented, one would think that they would need a larger workforce. This is one reason I doubt the government’s readiness for GST.

If in any case that the system fails to live up to its promise and Customs rushes GST deductions and refunds due to increased workload, many fraudulent claims would pass through the net, causing losses for the government[8].

Legal

The issue regarding the legal side of GST is a bit less intuitive than the previous point. Still, it is no less important.

GST is governed by a piece of legislation, the GST act. In the GST act, a very important section is the list of taxable and exempt supplies. Now, it may seem strange that there would be complications arising from such clear cut distinctions of what is taxable and what is not. I assure you that this is, in fact, true. The best way of demonstrating this is to study a real legal case.

Proctor & Gamble (P&G), manufacturer the potato crisps (or chips, if you’re American), Pringles, won a case in the UK High Court for their product to be exempt from VAT (same as GST), because the judge ruled that the product is in fact, not a crisp[8]. In the UK, crisps are taxable supplies whereas most foodstuffs are not[9]. P&G argued that Pringles, due to their ‘melt mouth’ taste, ‘uniform colour’, ‘regular shape’ which is ‘not found in nature’ and they contained non-potato flour unlike other crisps[10]. It was also argued that the tube packaging unique to Pringles distinguishes it from crisps[11]. The judged ruled that Pringles were found to fall outside the definition of crisps as the products, in all their flavours contain less than 50% potato[12]. The judge also agreed with most of P&G's arguments[13].

However, the Court of Appeal then overturned the decision on the basis that Pringles contained 42% potato which is sufficient to be reasonably viewed as to be made from potato, therefore are in fact, crisps and liable for VAT[14]. The tax amount in question was £100 million plus £20 million per year in the future. 

The above example shows that determining whether or not a supply is taxable is not as simple as it sounds and the amount of money in contention could be extremely sizeable.

If I remember correctly from one of my Tax Law lectures, there is also another case in Australia where the argument was on whether Italian shortbread is bread or biscuit, whereby bread is GST exempt whereas biscuit is not. In Australia, between 2011 and 2013, there are on average 3 GST-related cases every month[15].

Is our judiciary ready for this type of workload? One could argue that with Sales Tax, these cases would already have existed. However, it is important to go back to the point where many more businesses are affected by GST as compared to Sales Tax.

Conclusion

GST, taken on its merits as a system, is a beautiful piece of work. However, it entails much more work than our existing system. Given the track record of our government and civil servants, there is much room for doubt on the smooth running of a complex tax system. Don’t get me wrong, I am not outright accusing them of being too incompetent to do it. What I am saying is the level of assurance required for me to believe that it will be well run is pretty damn high.

If the government does it wrong, the tax revenue could fall short of expectations, requiring either the system and/or personnel to be revamped or raising the GST rate. I think we know very well which is the easier option.

Chong Yu Cheng

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[1] http://www.agc.gov.my/Akta/Vol.%202/Act%2064.pdf
[2] Ibid.
[3] http://malaysiantax.com/attachments/Malaysian-tax-PUA-355-Sales-Tax-2.pdf
[4] http://www.nbc.com.my/service-tax-in-malaysia.html
[5] http://www.freemalaysiatoday.com/category/business/2013/11/22/rmc-gst-at-6-to-raise-rm22b-revenue/
[6] T Pua, The Tiger That Lost Its Roar: a Tale of Malaysia’s Political Economy, Democratic Action Party, 2010.
[7] http://www.agc.gov.my/Akta/Vol.%202/Act%2064.pdf
[8] Ibid. 6.
[9] http://www.bakeryandsnacks.com/Markets/Pringles-are-not-crisps-rules-UK-court-in-VAT-case
[10] Ibid.
[11] http://news.bbc.co.uk/2/hi/8060204.stm
[12] Ibid. 9.
[13] Ibid. 9.
[14] Ibid. 9.
[15] Ibid. 11.
[16] http://chrissievers.com/gst-case-summaries-2/

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