Making It Less Taxing for Start-Ups
By Tan Hooi Beng, Deputy Tax Leader and Lee Boon Siew, Associate Director of Deloitte Malaysia
KUALA LUMPUR, 22 June 2021 - Malaysia is certainly not lagging in the entrepreneurial world of start-ups. In the last 5 years, the plethora of start-ups offering creative and cost-effective solutions to everyday requirements from transportation, healthcare, house renovation, among other, is testament that innovation is thriving. Look at Grab, a highly successful start-up with local origin, which is now a household name in Southeast Asia.
The headline-grabbing news of Grab’s proposed mega merger with US-based Altimeter Growth Corp has certainly caused many to ponder over the “what-ifs” for Malaysia had Grab’s headquarters remained in Malaysia instead of relocating to Singapore. The silver lining is that it is still not too late to start reflecting on the “what-could” measures to enhance the attractiveness and sustainability of Malaysia’s ecosystem for start-ups.
In fact, the first step has been taken through the launch of the Malaysia Digital Economy Blueprint in connection with MyDIGITAL, a national initiative to transform Malaysia into a digitally driven, high income nation and a regional leader in digital economy. Interestingly, the targets include attracting 2 unicorns (home-grown or foreign) and increasing the number of start-ups to 5,000 in the coming years.
While business-friendly regulations and ease of securing venture capital financing are typically cited by entrepreneurs as major factors in deciding where to locate their headquarters, the local tax regime also plays an important role in encouraging, harnessing and retaining start-ups. Tax incentives are already available for angel investors and venture capitalists who invest in promising businesses. What is needed to complete the equation are favorable tax measures for start-ups themselves.
Against this backdrop, here are some of our thoughts on potential measures:
1. Special corporate tax deduction of expenses incurred before commencement of business
Expenses are generally tax deductible if incurred in the normal course of business on activities that are part of the income producing process. However, suffice to say that expenses may be deductible only when incurred after business has commenced from a tax perspective. This means that monies spent on activities preparatory to carrying on business would typically not be deductible (referred to as “pre-commencement expenses” in the tax lingo).
Start-ups usually incur substantial amounts at their inception (often financed by the entrepreneur) to develop a minimum viable product, which is essentially a prototype to test their hypothesis with their target market and gather feedback, before commencing full scale commercial development. This prima facie tends to include pre-commencement expenses, hence, unlikely to be tax deductible.
To help aspiring entrepreneurs recoup some of these costs, the Government could consider allowing tax deduction to be claimed upon commencement of business. This should not be a new concept because our tax legislation already allows for deductions on certain pre-operational business expenditures incurred for an approved business venture outside Malaysia, which include feasibility studies and market research or the obtaining of market information. If this can be granted for a business venture outside Malaysia, surely such favorable treatment can, and rightfully should, also be granted for local businesses.
2. Special corporate tax deduction of expenditures incurred to develop or enhance product
Start-ups also invest significantly on product development (e.g. mobile application) which becomes their core income-generating asset. Upgrades are made periodically to ensure that it remains relevant amid changing consumer requirements and competition. Such expenditures typically comprise purchase of computer software, fees paid to app developers, intellectual property protection, staff costs, etc.
Costs attributable to initial development and subsequent upgrade of a business asset are generally regarded as capital expenditures which are not tax deductible, except for some where capital allowances (tax depreciation) may be claimable. For example, capital allowances are claimable over 4 consecutive years for development of customised computer software.
Since start-ups have taken risks in pioneering the development of their product and often suffer from a high rate of cash burn which threatens their survival, it would be great if the Government could allow full tax deduction of expenses incurred on initial development and subsequent upgrades. If full tax deduction in the year when the costs are incurred is excessive, then an ideal alternative would be over 2 years.
An even more exciting consideration would be something like Singapore’s previous Productivity and Innovation Credit scheme to encourage productivity and innovation activities. It granted enhanced deductions and / or allowances to businesses that invest in specified activities such as acquisition or licensing of intellectual property rights, research and development, and design.
3. Corporate tax exemption on profits earned
Currently, companies which are “Small and Medium Enterprise” for tax purposes enjoy preferential tax rates (17% on first RM600,000 and 24% on the subsequent balance). It would certainly be music to the ears of start-ups if the Government could also provide enhanced preferential tax rates for them. A full income tax exemption is always the best. However, we are cognizant that this may be unrealistic in present times when our national coffers are already stretched due to the many rounds of fiscal stimulus to shore up the economy amid the pandemic.
By doing this, the Government would be assisting start-ups seeking to reinvest their hard-earned profits for strategic growth such as further improvement of their product or regional expansion. It should also put Malaysia on a more competitive footing with Singapore which has a tax exemption scheme for new start-up companies for the first 3 years – 75% exemption on the first $100,000 and a further 50% exemption on the next $100,000.
4. Double tax deduction on promotion expenses
Start-ups also incur a lot on marketing, be it on traditional and / or digital platforms, to build brand awareness. It would be good if the Government could grant double deduction on such expenses, like what is currently available to companies which incur advertising expenditures on Malaysia brand name goods. This helps in defraying the costs as well as, more importantly, incentivises start-ups to invest in increasing their presence to become regional players and not mere jaguh kampung.
The Government could rely on recommendations from bodies such as MDEC, Cradle Fund and MIDA to ensure that only well-deserving start-ups with compelling value proposition are entitled to these preferential measures. We also think that these measures should be granted for a certain period only to prevent over-reliance on the Government. Start-ups should start paying their fair share of taxes once they earn sustainable recurring profits. The devil is in the details.
Should this be pursued, it would be beneficial to have a dialogue with industry stakeholders to ensure that the measures ultimately introduced are relevant and will have high take-up rate. While the G7’s recent endorsement of global minimum tax of at least 15% may have some impact on countries that offer tax incentives to multinationals, Malaysia’s tax incentives should continue to be robust and more so, for the local startups
The views and opinions expressed in this article are those of Tan Hooi Beng, Deputy Tax Leader and Lee Boon Siew, Associate Director of Deloitte Malaysia
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