This article first appeared in Forum, The Edge Malaysia Weekly on March 6, 2023 - March 12, 2023

Prime Minister Datuk Seri Anwar Ibrahim carefully avoided the dreaded Goods and Services Tax (GST) when he unveiled the revised Budget 2023. But he has proposed a Capital Gains Tax (CGT) on the disposal of shares in unlisted companies.

The new tax — which is subject to implementation after feedback from various industries — paves the way for the government to broaden its tax base and, in some ways, dip a toe into the informal economy.

The downside to such a CGT is that it can be detrimental in the longer term if the messaging about the measure and its implementation are not done properly.

According to some tax consultants, the imposition of CGT is cumbersome and may scare away investors if entrepreneurs are taxed heavily for making money out of a business that they have built over years.

The messaging should be clear. For example, how far back will the tax apply and would it be on a sliding scale or a flat rate? If a person builds a company over 10 years from a base of RM10,000 and sells it for RM100,000, how far back would he be taxed for the gain?

But the optimistic view is that the CGT is a way of broadening the tax base without affecting the pockets of the ordinary people. This is because there are instances where unlisted companies are used to undertake private deals to avoid scrutiny, red tape and reduce tax payments, if any.

Deals done through layers of unlisted companies can obscure the identity of the ultimate shareholders.

The tag “unlisted company” by itself means that the entity does not have to go through the scrutiny listed companies are subject to. Normally, they do not have an annual report and in most cases, the owner does not have anyone to answer to except the Inland Revenue Board (IRB) when the company files its annual returns.

Unlisted companies can be in the form of a sole proprietorship or a partnership, or have several shareholders. The core business can be anything from trading to provision of services or even investment holding. They are not synonymous with small and medium businesses and can also include listed companies that incorporate many unlisted firms.

The smaller unlisted companies are normally operated by individuals or in partnerships. The bigger businesses have a group of shareholders. And all of them maintain a set of accounts to be submitted to the IRB to get their business licence renewed.

Apart from enjoying a lower tax rate — which can be as low as 15% based on the latest budget — another reason for having unlisted companies is the ease of doing business and in taking up loans. Most companies would want to transfer cash to another company and not to individuals.

There are individuals who set up a private company to own a string of assets. All rental income and expenses are treated as part of the company’s business model. Maintenance and other expenses are also set off against the rental income.

Unlisted companies are also the major shareholders of many large listed companies.

A look into the shareholding of many listed companies will show that the major shareholders are normally unlisted private companies. These private companies can be very big, have several sources of income and own several listed companies.

A change in the shareholdings of these large private companies can take place for a premium without public scrutiny.

In a nutshell, the wealth within the realm of unlisted companies is huge. And most of them are usually below the radar of the public and the IRB because the gains are in the form of appreciation of capital. The capital is built up over several years, largely through entrepreneurship. An individual or a group of shareholders takes on risk to build a business and, in return, enjoys profits.

Currently, the tax that most unlisted companies are hit with is the Real Property Gains Tax (RPGT) if they own properties. And that too, if the unlisted company has no other businesses apart from the property it holds.

When the shares in unlisted companies change hands, there are no major taxes involved.

Would Anwar’s CGT kill entrepreneurship? And would it deter investment from multinational companies, which tend to set up private enterprises to reduce red tape and seek the most tax-efficient way to invest in the country?

It is not the first time that the imposition of a CGT on unlisted companies has been explored by the Ministry of Finance (MoF). It was brought up a few years ago but the various business groups felt that if the government wanted to increase its tax revenue base, GST was a better option. Their contention was that the GST, being a consumption-based tax, would capture the informal economy more effectively. They felt that if Singapore could have a 17% rate, why not Malaysia, at a much lower rate of 3%?

But for Anwar and Pakatan Harapan, the GST is a taboo subject. First, it was one of the biggest political issues that the party exploited in the 2018 general election. Eventually, the GST, together with the 1Malaysia Development Bhd (1MDB) fiasco and a united opposition front with Tun Dr Mahathir Mohamad as the leader, saw Barisan Nasional lose control of Putrajaya.

Secondly, the imposition of the GST would have an effect on the population at large. Prices would go up, adversely impacting the man on the street.

And if the refund mechanism were not well executed, the private sector would have cash flow constraints.

The CGT is not an alternative to the GST. But it will certainly broaden Malaysia’s current narrow tax base. And it impacts a small group of people who are probably better off than the ordinary wage earner.

Only some 2.5 million individuals out of a population of 33 million pay taxes. Corporate income tax makes up the bulk of the federal government’s revenue. But it is said that many companies, especially privately held enterprises, do not pay as much taxes as they ought to.

Therefore, the CGT on the disposal of shares of unlisted companies will broaden the tax base. But the implementation should be done carefully so as not to scare away investors and dampen entrepreneurship.

M Shanmugam is a contributing editor at The Edge

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