KPMG: Budget 2010 - Government's reaction in difficult times

The Minister of Finance Datuk Seri Najib Razak, who is also the Prime Minister, announced on Oct 23 the National Budget for 2010 entitled "1Malaysia, Together We Prosper".

The Budget is set against the back drop of a difficult economic climate and concerns for the need to contain and reduce the national fiscal deficit.

The Government's reaction to these issues has been positive. Instead of merely trying to contain and survive the effects of the global economic meltdown, the Government's aims are long term in nature and its intentions are to transform the Malaysian economy into a high income economy. As with anything else of this nature, the process of transformation will undoubtedly take time.

To achieve this transformation, the private sector has been thrust into the role of being the primary driver. The need to develop highly skilled human capital to propel the private sector has been recognized and measures have been proposed to achieve this.

The public sector's efficiencies will be enhanced to support the transformation of the Malaysian economy. The 2010 Budget also lays the foundation for the formulation of the 10th Malaysia Plan.

The Government's goal to transform the Malaysian economy is intended to be achieved by way of innovation, creativity and undertaking high value added activities. It is expected that the implementation of these measures will more than double the income of the rakyat in the next decade.

This article seeks to evaluate some of the key proposals to enable the Government to achieve its goal.

Attracting Foreign Direct Investment (FDI)

Competition both regionally and globally to attract FDI is stiff. To increase Malaysia's competitiveness in this area, the Government's aim is to remove potential barriers and ease the entry path of foreign companies to undertake economic activities in Malaysia. In this respect, previously, foreign participation in 27 services sub-sectors has been liberalized.

The Foreign Investment Committee's (FIC) guidelines on equity participation have been abolished (except where Bumiputera interests are diluted). It was announced in the 2010 Budget that Khazanah Nasional Bhd (Khazanah) and Permodalan Nasional Bhd (PNB) will enhance their collaboration with foreign investors in the areas of education, tourism and infrastructure.

It appears that foreign investors will be allowed equity ownership in companies and to participate in joint ventures in local projects in conjunction with Khazanah and PNB where this was not previously permissible.

This may have the dual impact of attracting FDI and reducing the costs of undertaking these projects to Malaysia. There is an additional benefit in that foreign investors may bring intellectual capital which will enhance development in these selected areas. One will have to wait and see the extent to which foreign participation will be allowed in other areas through joint ventures with Khazanah and PNB.

Research and Development (R&D) activities

Proposals in the 2010 Budget relating to R&D activities and the commercialization of the same could also serve to attract FDI and simultaneously encourage the undertaking of high value added activities in Malaysia. For this purpose, a four prong strategy has been proposed :

* Rationalizing all research funds and grants in order to be more effective to achieve set targets;

* Establishing a National Innovation Centre supported by a network of innovation excellence centres under the Ministry of Science, TECHNOLOGY [] and Innovation in collaboration with the Ministry of Higher Education;

* Integrating R&D activities with patent, copyright and trademark registration to ensure that the R&D and the commercialization of R&D is implemented more effectively. The cooperation between patent and research agencies will expedite the commercialization of research findings; and

* Providing small and medium enterprises with tax deductions for expenses incurred in the registration of patents and trademarks in the country. In the tax context, "small and medium enterprises" generally refer to companies with a paid up ordinary share capital of RM2.5 million or less.

While the tax deduction proposed may encourage investments in R&D activity, it is limited to small and medium enterprises only. Among other factors, balancing the need to limit legal liabilities to the extent of the paid up share capital of the company and encouraging investment in this sector should perhaps be the purview of the businessman. The tax incentive currently proposed could be broadened to attract wider participation in this sector by removing the limitation based on share capital.

The above fiscal measures could complement the existing incentives already provided to R&D activities. These existing incentives include double deductions for qualifying R&D expenditure incurred and awarding Pioneer Status to companies that conduct qualifying R&D activities.

In the area of education

In order to transform the Malaysian economy into a high income economy and, among other things, attract FDI, it is recognized that there is a need to develop high quality human capital. For this purpose, measures have been proposed to enhance the Malaysian education system. An allocation of RM30 billion for primary and secondary education has been proposed. These measures are expected to benefit 5.5 million students in Malaysia.

Measures relating to the care of the welfare of students have also been proposed to enhance the education system. These include proposals on the awards of scholarships, discounts on train fares and encouraging the use of information technology by students.

To accelerate the achievement of the Government's goals in relation to the development of high quality human capital, the Government may consider encouraging the private sector to participate in the education sector. Fiscal incentives could include granting double deductions on relevant expenses.

In the area of Islamic finance

Malaysia has already achieved the status of being the world's largest issuer of sukuks with approximately 62%, or USD94.7 billion, of outstanding global sukuks in 2008. To ensure the rapid development of Islamic financial services, the following tax measures are proposed :

* An extension to 31 December 2015, of the remission of 20% of the stamp duty payable on the principal or primary instrument of financing made according to the principles of Syariah.

* The extension of the incentive to allow a tax deduction on the costs incurred to issue Islamic securities under specified Syariah principles approved by the Securities Commission (SC) until the Year of Assessment (YA) 2015. In addition, it is also proposed that the above incentive is to be extended to the cost of issuing Islamic securities approved by the Labuan Offshore Financial Services Authority (LOFSA) with effect from YA 2010 to YA 2015.

* The extension of the incentive to allow a double deduction on qualifying expenses incurred to promote Malaysia as an International Islamic Financial Centre until YA 2015.

* The extension of the incentive to allow a tax deduction on the costs incurred to establish companies undertaking licensed Islamic stock broking businesses incorporated under the Companies Act 1965 for applications received by the SC until 31 December 2015.

* The extension of the tax exemption on profits paid or credited to any person in respect of Islamic securities (except convertible loan stock) originating from Malaysia issued in any currency other than Ringgit and approved by the SC, to include profits paid or credited in respect of Islamic securities approved by LOFSA.

The above measures should have the effect of encouraging further growth of the Islamic financial markets in Malaysia. These proposals could also reduce the cost of raising capital through the Islamic capital markets.

Overall, the measures proposed in the 2010 Budget should have the effect of moving Malaysia along the path to transformation. It is noteworthy that the Minister of Finance announced during the 2010 Budget speech that the Government is in the final stage of completing its study on the implementation of a Goods and Services Tax (GST) system. The issue of whether or not GST will be introduced is the tax question that should now be on people's minds.