Introduction of tax incentives

When investigating corporate taxation in developing countries it is difficult to ignore the use of
tax incentives. According to Klemm (2010), tax incentives are defined as all measures that
provide explicitly for a more favorable tax treatment of certain activities or sectors compared to
what is granted to the general industry. Under this definition, a general cut in the tax rate or a
generous depreciation scheme applicable to all firms would not be considered tax incentives,
(Klemm, 2010).

Tax incentives defines as fiscal measures used by governments to attracts investment

domestically and internationally in certain key sectors of the economy, (Bolnick, 2004). Tax
incentives also can defines in statutory and effective terms, (Zee and Stotsky et al., 2002). A
statutory tax incentive is a special tax provision granted to qualifying investment projects and
this provision would not be applied to other investment projects outside the selected qualifying
categories. An effective tax incentive is a special tax provision granted to qualifying investment
projects with the goal of reducing the effective tax burden, (Zee and Stotsky et al., 2002).

International tax competition is an important force behind many tax incentives. Many developing
countries use tax incentives to reduce the tax burden for foreign investors. If tax incentives are
granted on a discretionary basis, firms have to spend time and money lobbying at the government.
Companies may also spend considerable amounts of time and money to qualify for and obtain
tax incentive, (James, 2009).

Many developing countries use tax incentives to promote investment. The use of tax incentives
may bring along important costs for the country. The poor performance of tax administrations
and the high compliance costs for investors may disturb the effectiveness of tax incentives. Tax
incentives should therefore be subject to legislative process, consolidated under the tax law, and
their fiscal costs reviewed annually as part of a tax-expenditure review.
There are different types of tax incentives offered in Malaysia in the form of tax exemptions,
allowances related to capital expenditure and enhanced tax deductions. Although the income is
exempted from tax, tax will have to be paid on the dividends paid on tax exempted income. In
the case of allowances, there is a provision to carry forward the unutilized allowances until is is
utilized fully.

In Malaysia, tax incentives, both direct and indirect, are provided for in the Promotion of
Investments Act 1986, Income Tax Act 1967, Customs Act 1967, Sales Tax Act 1972, Excise
Act 1976 and Free Zones Act 1990.

Direct tax incentives are exempt from partial or total reduction in income tax for a specified
period of time. The form of indirect tax incentives is exempt from exempt import duties, sales
taxes and excise duty.

The tax incentives offered by the Malaysian Government are manifold and wide in its application
to industries and businesses. These tax incentives are constantly subject to change through
refinements, updates, withdrawals as well as repositioning to meet the challenges and needs of
the Malaysian economy.
 1. Incentive for Research and Development

Malaysia introduced research and development tax incentive scheme in year 1982 as a 133%
elevated deduction, soon increasing the benefit to an attractive, internationally competitive
double deduction (200%) in year 1986.

This incentive measure under Section 34A of the Act provides for a double deduction in respect
of qualifying research expenditure (which is revenue in nature) related to a research programme
undertaken by a business entity, the double deduction is made in arriving at the adjusted income
of the business.

According to Promotion of Investment Act (PIA) 1986 Section 2 defines R&D as any systematic
or intensive study carried out in the field of science or technology with the object of using the
results of the study for the production or improvement of materials, devices, products, produce or
processes.

R&D Company
A company that provides R&D services in Malaysia to its related and/or unrelated companies
can enjoy:
 Investment Tax Allowance (ITA) of 100% of qualifying capital expenditure incurred within
a period of 10years and can be offset against 70% of statutory income for each year of
assessment.
Only unrelated companies can claim double deduction for the payment made to the R&D
Company for the use of their R&D services.
Contract R&D
A company that provides R&D services in Malaysia to its unrelated companies can enjoy:
 Pioneer Status (PS) with income tax exemption of 100% on statutory income for 5 years or,
 Investment Tax Allowance (ITA) of 100% of qualifying capital expenditure incurred within
a period of 10 years and can be offset against 70% of statutory income for each year of
assessment.
Only unrelated companies can claim double deduction for the payment made to the R&D
Company for the use of their R&D service.

In-house R&D
A company carries out R&D within the company in Malaysia for the purpose of its own business,
can enjoy:
 Investment Tax Allowance (ITA) of 50% of qualifying capital expenditure incurred within a
period of 10 years, the ITA can offset against 70% of statutory income each year of
assessment.

2. Incentive for Strategic Projects

Strategic projects involve products or activities of national importance. They generally involve
heavy capital investments with long gestation periods, have high levels of technology, and are
integrated, generate extensive linkages, and have significant impact on the economy, such
projects qualify for:
 Pioneer Status (PS) with a tax exemption of 100% of the statutory income for a period of 10
years or
 Investment Tax Allowance (ITA) of 100% on the qualifying capital expenditure incurred
within five years from the date the first qualifying capital expenditure is incurred. This
allowance can be offset against 100% of the statutory income for each year of assessment.
Applications should be submitted to MIDA.
 3. Tax Incentives for Green Industry in Malaysia

On 25 October 2013, the Prime Minister of Malaysia had declared the Green Technology Tax
Incentive for the acquisition and use of green technology in the Budget 2014 (GUIDELINES
FOR GREEN TECHNOLOGY TAX INCENTIVE (GITA GITE), 2018). The Government will
continually offers Investment Tax Allowance (ITA) for the acquisition of green technology
equipment or assets and Income Tax Exemption (ITE) for green technology service providers
in order to reinforce the development of green technology in all Malaysia’s industry. (MIDA |
Malaysian Investment Development Authority).

The incentives announced in Budget 2014 cover a broader range of green technology activities in
the areas of energy, transportation, building, waste management and service. It also facilitates the
transfer of the expired (by 31 December 2015) renewable energy (RE) and energy efficiency (EE)
tax incentives under the Investment Act (PIA), 1986 (MIDA | Malaysian Investment
Development Authority).

According to (GUIDELINES FOR GREEN TECHNOLOGY TAX INCENTIVE (GITA GITE),

2018) The purposes of the green tax incentives are:

 Encouraging project-based investment in green technology for either business or own use
 Motivating companies to acquire green technology assets
 Increasing the number of providers in green technology

According to (Abdul, 2013), the national schema of the green tax incentives are :

 Reducing the energy consumption rate while at the same time increasing economic
growth
 Facilitating green technology industry growth and increasing its contribution to the
national economy
 Enhancing national capacity and capability for innovation in green technology
 Enhancing the public awareness on green technology as well as education to widespread
its use
 Conserving the environment for future generations
Tax Incentive for Purchase of Green Technology Assets

FEATURES DESCRIPTION
Definition • Purchase of green technology equipment which has been certified by
recognized verification bodies and listed in MyHijau Directory
Eligibility • Companies that had incurred qualifying capital expenditure in green
technology investment and complying ALL of the following criteria:
a) minimise the degradation of the environment or reduce greenhouse
emission;
b) promotes health and improvement of environment; and
c) conserves the use of energy, water and/or other forms of natural
resources or promote the use of renewable energy or able to recycle
waste material resources.
Rate of • Green Investment Tax Allowance (GITA) of 100% of qualifying capital
incentive expenditure incurred on approved green technology asset from the year of
assessment 2013 (date on which the first qualifying capital expenditure
(GUIDELINES incurred is not earlier than 25th October 2013) until the year of assessment
FOR GREEN 2020.
TECHNOLOG • The allowance can be offset against 70% of statutory income in the year of
Y TAX assessment.
INCENTIVE Unutilized allowances can be carried forward until they are fully absorbed.
(GITA GITE),
2018)
Commencemen • The eligibility period would be for qualifying capital expenditure incurred
t date from the year of assessment 2013 (date on which the first qualifying capital
expenditure incurred is not earlier than 25th October 2013) until the year of
assessment 2020.
List of
Qualifying
Assets

Tax Incentive for Green Technology Services

FEATURES DESCRIPTION
Definition Provision of services to Green Technology user / project
Eligibility Green Income Tax Exemption given to qualifying companies which
provides green technology services which have been verified by
GreenTech Malaysia and been listed under the MyHIJAU Directory.
For a company which undertakes green technology services activities, the
company must meet the criteria of green technology service providers as
follows:
a) At least one competent/qualified personnel in the respective green
technology;
b) Must have a green policy related to the environmental or sustainability;
and
c) 100% income must be derived from the respective green technology
 services.
Note :
 Competent personnel are defined as holding a certificate of
competency as a service provider in the related field of green
technology. The certificate must be recognised by the Government
or a Professional Body in Malaysia
 Green Policy is a statement about the commitment to sustainability
and environment management by the company
The application must be submitted to MIDA before 31 December 2020.
Rate of 100% of statutory income from the year of assessment 2013 until the year
incentive of assessment 2020 (maximum period is 5 years from the date of
commencement)
.
Commencement • Depending on the nature of the business activity, the commencement date
date for the incentive shall be determined by MIDA (up to the year of
assessment 2020)
List of
Qualifying
Activities
Tax Incentive for Green Technology Project

FEATURES DESCRIPTION
Definition  Investment in assets/ equipment / system to undertake a Green
Technology project
Rate of  Green Investment Tax Allowance (GITA) of 100% of qualifying
incentive capital expenditure incurred on green technology project from the
year of assessment 2013 (date on which the first qualifying capital
expenditure incurred is not earlier than 25th October 2013) until the
year of assessment 2020.
 The allowance can be offset against 70% of statutory income in the
year of assessment.
 Unutilized allowances can be carried forward until they are fully
absorbed.
Commencement  The eligibility period would be for qualifying capital expenditure
date incurred from the year of assessment 2013 (date on which the first
qualifying capital expenditure incurred is not earlier than 25th
October 2013) until the year of assessment 2020.
List of
Qualifying
Activities
According to (Nur Khairah Alegria Suner, 2017), Green development project in Malaysia have
increased significantly as more developers and investors are strained to the “green” tax
incentives and cost-saving initiatives provided by the government. Developers and investors
strive for ' green ' construction because they know that they can then benefit from the tax
incentives(Nur Khairah Alegria Suner, 2017).

Several buildings in Malaysia also won Asean awards for their green designs and initiatives.
They include the Energy, Green Technology and Water Ministry’s building, the Energy
Commission building in Putrajaya and the Securities Commission Building in Kuala Lumpur.
 4. Incentives for Small and Medium Enterprises

Small and Medium Enterprises (SMEs)

The classification of SMEs (small and medium enterprises) for the purpose of income tax and tax
incentives is defined as a company resident in Malaysia with a paid up of ordinary shares capital
of RM2.5million or less at the beginning of the basis period of a year of assessment whereby
such company cannot be controlled by another company with a paid up capital exceeding
rm2.5million, effective from the Year Assessment (YA) 2009 under (MIDA | Malaysian
Investment Development Authority)

According to (MIDA | Malaysian Investment Development Authority), SMEs with a chargeable

incomes of up to RM500,000 are eligible for a reduction of 20% on chargeable incomes. The 25%
tax rate on the remaining chargeable income is retained.

Small Scale Companies

Small scale companies incorporated in Malaysia are eligible for tax incentives if their
shareholders’ fund is not more than RM500, 000 and have minimum Malaysian equity of 60%
under the Promotion of Investment Act (PIA), 1986, (MIDA | Malaysian Investment
Development Authority). According to MIDA, small scale companies incorporated in Malaysia
are re-classified as companies with shareholders’ fund not more than RM2.5 million and have
Malaysian equity of 60% to 100% with Effective from 3 July 2012.

The small scale companies must meet the following requirement:

i. Incorporated in accordance with the Companies Act 1965.

ii. Shareholders' fund not more than RM2,5 million with the following Malaysian equity
ownership :

• Minimum 60% Malaysian equity with shareholders’ fund up to M500,000

• 100% Malaysian equity and shareholders’ fund up to RM500, 000 to RM2.5 million.
The following incentives are entitled for small scale companies:

i. Pioneer Status with income tax exemption of 100% of the statutory income for a period
of five years. Unabsorbed capital allowances as well as accumulated losses incurred during the
pioneer period can be carried forward and deducted from the post pioneer income of the
company; or

ii. Investment Tax Allowance of 60% on the qualifying capital expenditure incurred within
five years. This allowance can be offset against 100% of the statutory income for each year of
assessment. Any unutilized allowances can be carried forward to subsequent years until fully
utilized.

In Malaysia, 97.3% of business establishments comprise of SMEs. They contribute to 33.1% of

the nation’s gross domestic product (GDP), 57.5% of the nation’s employment and 19% of the
nation’s export (Star, 2018). According to (Hamid, Noor and Zain, 2011), one of the factors that
leads to the success of SMEs in the roles of government in promoting the tax incentives
programs to SMEs. SMEs are encouraged by MIDA to apply for tax incentive if they fulfill the
entire requirement. MIDA will assist them by making the tax incentives application process
simple (Hamid, Noor and Zain, 2011).
 5. Incentives for tourism

(“Incentives for the Tourism Industry – CAPITAL,” 2015)

Incentives for the Hotels and Tourism Projects

Companies undertaking new investments in 1 to 5 star hotels and tourism projects are eligible for
the following incentives(“Incentives for the Tourism Industry – CAPITAL,” 2015):

1. Pioneer Status

A company granted Pioneer Status enjoys a five year partial exemption from the payment of
income tax. It will only have to pay tax on 30% of its statutory income, commencing from its
Production Day which is determined by the Minister of International Trade and Industry.

Unabsorbed capital allowances as well as accumulated losses incurred during the pioneer period
can be carried forward and deducted from the post pioneer income of the company.

Applications should be submitted to MIDA before commencement of business.

2. Investment Tax Allowance

As an alternative to Pioneer Status, a company may apply for Investment Tax Allowance (ITA).
A company granted the ITA gets an allowance of 60% on the qualifying capital expenditure
incurred within five years from the date on which the first qualifying capital expenditure is
incurred.

Companies can offset this allowance against 70% of statutory income in the year of assessment.
Any unutilised allowances can be carried forward to subsequent years until fully utilised.

Applications should be submitted to MIDA before commencement of business.

Applications for 4 and 5 star hotels received by 31 December 2020 are eligible for these
incentives.
 3. Enhanced Incentives for Undertaking New Investment in Hotel

Companies undertaking new investments in 4 and 5 star hotels in Sabah and Sarawak are eligible
for the following incentives:

1. Pioneer Status, with income tax exemption of 100% of the statutory income for a
period of five years. Unabsorbed capital allowances as well as accumulated losses
incurred during the pioneer period can be carried forward and deducted from the
post pioneer income of the company; or

2. Investment Tax Allowance of 100% on the qualifying capital expenditure

incurred within a period of five years. The allowance can be offset against 100%
of the statutory income in each year of assessment. Any unutilised allowances can
be carried forward to subsequent years until fully utilised.

Applications received by 31 December 2020 are eligible for these incentives.

Applications should be submitted to MIDA before commencement of business.

4. Incentives for Reinvestments in Hotels

Companies that reinvest in the expansion and modernization in 1 to 5 star hotels are eligible for
additional rounds of Investment Tax Allowance as follows:

60% (100% for 4 and 5 star in Sabah and Sarawak) on the qualifying capital expenditure
incurred within a period of five years. The allowance can be offset against 70% (100% for 4 and
5 star in Sabah and Sarawak) of the statutory income in each year of assessment. Any unutilized
allowances can be carried forward to subsequent years until fully utilized.

Companies are eligible to apply for ITA for the three rounds of reinvestments. For group of
companies, only 3 companies in a group are eligible for tax incentives. (See List of Promoted
Products and Activities - Reinvestments)

Applications should be submitted to MIDA before the first qualifying capital expenditure is
incurred.
 5. Incentive for Reinvestment in Tourism Projects

Companies that reinvest in the expansion and modernization in tourism projects are eligible for
additional rounds of Pioneer Status or Investment Tax Allowance as follows:

1. Pioneer Status, with income tax exemption of 70% of the statutory income for a
period of five years. Unabsorbed capital allowances as well as accumulated losses
incurred during the pioneer period can be carried forward and deducted from the
post pioneer income of the company; or

2. Investment Tax Allowance of 60% on the qualifying capital expenditure incurred

within a period of five years. The allowance can be offset against 70% of the
statutory income in each year of assessment. Any unutilized allowances can be
carried forward to subsequent years until fully utilized.

According to statistics provided by Tourism Malaysia’s website, there is a growth of tourist

receipts of 18.8% from RM69.1 billion in 2015 to RM82.1 billion. Also, tourist arrivals last year
stood at 26.76 million, a 4% increase from the previous year (CHESTER CHIN, 2017). The
Government will continue to boost investments mainly in new 4 and 5 star hotels in order to
further promote Malaysia as a favored tourist location.(Star, 2013)

Additional stimulus was given to tourism investment; this includes the Pioneer Status Investment
Tax Allowance, Industrial Building Allowances, and tax exemption for large foreign group tours.
There are huge opportunities for investment in both tourism and travel sectors of Malaysia.
Tourism Promotional Board identifies and create potential investment opportunities in many
areas; from retail and services to hospitality and travel. Many tax incentives were reviewed to
attract foreign investors. Investment opportunities which are granted tax incentives include
tourism projects like hotel businesses, recreational projects as well as the construction of holiday
camps and convention centres.(Mosbah & Abd Al Khuja, 2014)
Effectiveness means that tax incentives meet their stated objective. This can be evaluated
regardless of the related expenses that will be investigated subsequently. To achieve the
‘effectiveness’ measures, the increasing in investment and FDI is not enough, the kind envisaged
to yield the desired social benefits in broader welfare terms should be taken into account(Options
for Low Income Countries’ Effective and Efficient Use of Tax Incentives for Investment).

Tax incentives become a significant part in attracting new investment and stimulating economic
growth in some countries such as Korea and Singapore. Korea and Singapore attract investment
by given tax incentives. However, if incentives are overgenerous or poorly designed they can
result in giving money away without affecting investment and operating decisions. Even worse,
incentives can be captured by politically connected firms and used as a merry-go-round for
diverting public funds into political finance. And they can incentivise perverse results (such as
stretching out investment over time to extend the tax holiday such as was reported in the case of
Dangote Cement and the Pioneer Status exemption in Nigeria).

Indirect revenue costs arise from taxpayers abusing the tax incentive regime. For example, if tax
incentives are only available to foreign investors, local firms may use foreign entities to route
their local investments in order to qualify. Similarly, if tax benefits are available to only new
firms, taxpayers may reincorporate or set up new corporations to be treated as a new taxpayer
under the tax incentive regime. Other leakages occur where taxpayers use tax incentives to
reduce the tax liability from non-qualified activities. Preventing such losses requires proper anti-
abuse rules and regulations and strong administrative capacity to enforce them.
Merits of tax incentives

 Correcting market failure

The purpose of the government introduce and implement a variety types of taxation tools is to
achieve socially desirable socio-economic environment (Bird, 1993). Taxation tools help
government allocate the resources more efficiently, income reallocation and generate revenue to
support government operations. Governments use taxes to correct market failures. For example,
the under-production of investment activities by private sector is revised by using tax incentive
to correct it, thus generate positive externalities (Munongo, Akanbi, & Robinson, 2017).
Governments will seek to correct investment decisions of the private sector using tax
incentives and harness investment that would have not occurred without tax incentives. This
is because governments want the economy to enjoy the benefits of foreign capital which include
technological transfer, skills transfer, employment creation and economic growth and
development.

 Tax competition

Tax incentives may be used by countries to increase their revenue base by improving their
competitiveness (Klemm, 2009). This is useful in countries that wish to attract mobile
capital but face revenue constraints. Countries will offer tax incentives to mobile capital and
attract investment while getting revenue by taxing existing capital and immobile capital.
Demerits of tax incentives

 Revenue loss

According to Easson & Zolt (2002) cited by (Munongo et al., 2017), there are two types of
revenue loss due to tax incentives. Firstly, foregone projects losses due to the discourage of tax
incentives in other investments. Secondly, revenue is lost since businesses will improperly
claim incentives and in some instances shift income from taxable activities to those that fall
under tax incentives thereby avoiding tax.

 Misallocation of resources

The success of tax incentive policies means that investment will increase in regions and
nations within the successful incentive structures thus reducing investment in those that do not
have the incentives (Bird, 1993). This increase in investment due to tax incentives in some cases
will correct market failures while in most instances it may lead to too much investment in
activities that have incentives and reduced investment in those activities without incentives,
thereby leading to misallocation of resources.

 Encourages corruption

Tax incentives give bureaucrats the opportunity to engage in corrupt and rent-seeking
activities (Easson & Zolt, 2002). This is prevalent in cases where tax incentives give the
authorities discretion to determine which projects qualify for incentives and which do not. Tanzi
(1998) suggests that corruption is high with tax incentives, due to direct links between
investors and government authorities who use their discretion in implementing tax incentives.
The empirical findings by Zelekha & Sharabi (2012) show that tax incentives lead to
significant corruption. The study employed a large cross-section of European countries and two-
stage least square analysis to reach the conclusion.
Conclusion

In conclusion, tax incentive has many effectiveness and effects. Tax incentive is important to a
developed country. An argument can be made that tax incentives are a rational and beneficial
response to the pressures of tax competition, because they permit, in principle, the combination
of a competitive tax system for mobile activities with higher taxes elsewhere. Providing
incentives can create risks that might have implications for the investment climate and overall
fiscal compliance. It also encourages lobbying and rent seeking. Effective tax incentive schemes
can be difficult to design and not especially transparent, again especially if they are highly
targeted and/or apply only to incremental investment.
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