Last month, Parliament passed a bill enabling the imposition of sales tax (6%) on foreign digital service providers starting 1 Jan 2020. Thus far, 19 countries have implemented some form of “digital tax” while another 9 (including Malaysia) are at the planning stage. This digital tax could generate RM449m in Govt revenue (MoF: RM300-500m) but would be insufficient to reduce the 2020 budget deficit target of 3.0%. Impact to the media sector should be minimal as (i) comparative price gap between Astro and Netflix would still be large at 43% and (ii) target market for dimsum (Star) and Netflix are vastly different (i.e. Chinese vernacular vs English).

Implementing the digital tax. Last month, the Service Tax (Amendment) Bill 2019 was passed in Parliament. This enables Putrajaya to impose tax on foreign digital services such as software, music, video and online advertising. The “digital tax” has been fixed at a rate of 6% and is slated to come into effect on 1 Jan 2020 with RM500k p.a. as the threshold set.

Who gets taxed? Digital service is defined as “any service that is delivered or subscribed over the internet and other electronic network which cannot be obtained without the use of information technology and where the delivery of the service is essentially automated.” The tax will be applicable to digital service providers operating out of Malaysia which have revenue contribution from Malaysia. This requires foreign digital service providers to assess the number of Malaysian customers that they have, and if the associated revenue exceeds RM500k p.a., they will be required to pay a 6% tax on it. There are several ways that foreign digital service providers can determine their number of Malaysian customers. This includes determining if the paying customer has a Malaysian address, phone number, IP address and credit or debit card issued by a Malaysian bank.

Levelling the playing field. Currently, local digital service providers are required to pay a 6% service tax on purchases of their service under SST2.0 (which replaced the now defunct GST in Sept 2018). Essentially, this impending digital tax can be viewed as an extension of SST2.0 to encompass foreign digital services to ensure a level playing field for locals. For example, subscribers currently have to pay 6% service tax for iflix (local) but not for Netflix (foreign) which results to an unlevelled playing field in favour of the latter. Some of the popular foreign digital services that are expected to be hit by the digital tax include Netflix, Spotify, Amazon, advertisements on social media platforms such as Facebook and Instagram, cloud computing, smartphone apps and games. The foreign service providers will have a choice to either (i) pass on the imposed tax to consumers via a 6% price increase or (ii) maintain prices and absorb the tax.

Online purchase of goods not directly impacted. The digital tax will not apply to online purchases of goods. This is because goods purchased online from a foreign seller would have already been subjected to import duty and sales tax. However, if a foreign online portal charges a fee to sellers for selling their goods on its marketplace (i.e. a digital service), that fee would be subjected to digital tax if it were earned from Malaysia.

Enforcement issues. In our view, the main challenge for the Malaysian government would be getting foreign digital service providers to register for tax. While the larger ones may comply (for reputational reasons), this could be an issue for smaller players. Also, it could be difficult to identify which of the smaller players derive revenue in excess of RM500k p.a. from Malaysia. We feel there are 2 possible ways in which enforcement can be done by the Malaysian government on foreign providers that do not register for tax: (i) block their websites/ apps and (ii) working with local banks to block payment transactions to them. The Deputy Finance Minister has called for foreign digital service providers to register with the Royal Malaysian Customs from 1st Oct to 31st Dec this year. Under the bill, tax defaulters can be fined up to RM50k, imprisonment for up to 3 years, or both.

The experience overseas. Based on an article by Quaderno, a total of 19 countries have already implemented some form of digital tax on foreign service providers (the earliest being Norway in July 2011). The article also mentioned that another 9 countries are planning to implement the digital tax: Bangladesh, Canada, China, Colombia, Gulf States, Israel, Malaysia, Singapore and Thailand. For those countries that have already implemented digital tax, they are mostly an extension of their existing consumption tax (i.e. sales tax, VAT, GST) to encapsulate digital services offered by foreign service providers. This model is similar to what Malaysia has proposed to implement.

Potential revenue from digital tax. To assess the potential digital tax revenue from foreign service providers for Malaysia, we have extrapolated this based on the estimates for South Korea and adjusted for differences in population, internet penetration and tax rate. South Korea will extend its VAT (10%) to foreign digital service providers starting 1 July 2019 and is expected to generate tax revenue of KRW400bn (USD336m) annually. Based on its population with internet access of 47.7m, the estimated annual “digital tax per 1% per population” is KRW839 (roughly RM3.02). If this estimate is applied to Malaysia’s internet access population of 24.8m at a 6% rate, the digital tax could potentially generate RM449m in annual tax revenue. We note that our estimate is within the range shared by MoF of RM300-500m during our recent meeting with them.

Insignificant impact to budget deficit. During the 11MP mid-term review (Oct 2018), it was stated that Malaysia’s budget deficit target would be 3.0% by 2020 (2019: 3.4%). We calculate that the incremental RM449m digital tax estimation in 2020, ceteris paribus, would have no significant impact in moving the deficit needle (i.e. from 3.0% to 2.97%).

Minimal impact to media sector. We believe that the implementation of digital tax on foreign service providers would have limited positive impact (if any) to local pay-TV and OTT (over-the-top) players and maintain our UNDERWEIGHT rating on the media sector. For Astro (HOLD, TP: RM1.59), its entry package (non-NJOI) for non vernacular movies (i.e. Stars Pack) is priced at RM78.44/month (net of 6% service tax and rebates). With a 6% digital tax levied on Netflix, its entry package would cost RM44.52/month, which would still be 43% cheaper than Astro. We reckon that the price gap would still be too large to entice price driven substitution from Netflix to Astro. In the case of Star (HOLD, TP: RM0.68), its video-on-demand platform dimsum is priced at RM13.90/month. While this is much cheaper than Netflix, we note the significant difference in target market; Netflix caters to English speaking subscribers while dimsum targets the Chinese speaking segment with its vernacular content.

Source: Hong Leong Investment Bank Research - 14 May 2019