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How Does Shadow Economy Affect Malaysia’s Income Tax?

BY Nuris

Updated 28 Feb 2022

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*This article has been translated by Nisya Aziz.

Recently, Malaysian gahmen has declared war on shadow economic activities in the country. This call was made clear by the Minister of Finance Malaysia, Lim Guang Eng, during his keynote address at the last National Taxation Seminar 2019. The battle continues today.  

On top of that, several government agencies like the Malaysian Inland Revenue Board (LHDN) and the Malaysian Anti-Corruption Commission (MACC) are strengthening their SOPs to combat the said activity. 

According to Lim, as of 2019, the shadow economy is at 21% of the size of the country's GDP or RM300 billion (bn). Wow, just think of the benefits that the average citizen can enjoy with the amount to be deducted from the figure - Must be a lot, right? 

What's covered in this article?

So, what exactly does this shadow economy mean?

Akhbar Satar, who’s a Malaysian criminologist and the President of The Malaysian Association Certified Fraud Examiners (MACFE) shared that the shadow economy is also known as the underground economy where it’s often associated with criminal activities. Some of the examples are smuggling of weapons, tobacco, drugs, prostitution, illegal and online gambling, passport fraud and human trafficking. 

But, that’s not all.  The shadow economy also covers the unregistered formal sectors e.g. unlicensed businesses, freelancers, part-time workers and the cash economy. This includes those who have permanent employment, but at the same time have side jobs that generate substantial income and are larger than permanent income! 

It doesn’t matter lah if you sell Tupperware, run a tuition class, do MLM or whatnot, as long as it generates additional revenue and it’s not reported to the relevant agencies such as the IRBM - it's considered a shadow economy. Ha, are you one of them? Go ahead and audit yourself.


What’s the impact of the shadow economy?

No doubt the shadow economy figures will continue to grow over time, especially with the current trend of the gig economy. But, why does the government care so much about this shadow economy? Got nothing else to do meh?

Okay, first we need to understand that formal sector workers in Malaysia who contribute to the country's GDP are taxed on their income after the income earned exceeds the level of eligible income. Second, tax revenue is the country's main source of income contributing 50% to 55% of the country's annual revenue

That said, there aren’t many people who pay income tax, you know, and most of these people work in the formal sector - which isn’t fair because what about those working in the informal sector (in the context of the shadow economy), right? They will continue to be free from paying income tax. To add, the gahmen is even forced to introduce new taxes or raise tax rates as the country's revenue is reduced and collected below the actual figures.

That is why strict action should be taken on this issue especially in the area of ​​taxation as it can be returned to the people regardless of race, religion or culture. Imagine a quarter of the RM300bn figures were successfully licensed and how much revenue could be collected and used for economic and infrared development.

Of course, generally, these shadow economic problems cannot be fully solved, but they can be minimised by putting the law at the forefront of every economic activity. At least this economic activity can be taxed and the proceeds can be returned to the country in subsidies and development.

What can be done to reduce the loss of national income due to the shadow economy?

LHDN’s Role

In this context, LHDN’s tracking activities are also critical in detecting those who have failed to report their income despite having doubled their income compared to those who earn modest income but still pay income tax. As mentioned, a mandate has been given to LHDN to continue strengthening their SOPs.

Source: The Malay Mail

Nevertheless, LHDN does acknowledge the fact that they’re having a hard time detecting this economic activity as it comes from the hidden and informal sectors. This had led LHDN to developed the Revenue Transformation Plan by incorporating the capabilities of big data, analytical and artificial intelligence to help enhance compliance, plug loopholes and check losses.

Aside from that, tax education activities will also be intensified to create a knowledgeable society and to promote taxation to the country.


Rakyat’s Role

In this aspect, the agency is not able to solve this problem on their own - which means the rakyat needs to be the eyes and ears of the authorities. Of course, we Malaysians prefer to mind one's own business, right? But, if you see anything suspicious, you should have the habit of reporting it to the authorities (a different thing from being a kepochi).

For example, if you see a person having a large number of assets but only working for a living wage then there is certainly a reasonable suspicion that the agency can evaluate and investigate - not because you're jealous or salty about it, but you care about your country's economy.


Gahmen’s Role

We all know that the gahmen is seen as a key pillar of any issues that arise in any country (even though that’s not always the case). With all the conundrums that are happening in the country, whether it’s economic or political, there’s a need to increase rakyat's confidence in government integrity. One of the key steps is to provide accurate information on where the country's revenue is spent

That aside, it’s also hoped that the upcoming introduction of the Tax Identification Number (TIN) initiative for all business activities and individuals above 18 years of age would curb the leakage of national revenue from this shadow economic activity.

All in all, all parties need to play a role in the fight against shadow economic activities which appears to undermine the country's ability to collect income tax revenue. Without sustainable results, how can the government be able to make its people happy in a variety of ways and styles?

Share with us your thoughts.

*The above article is intended for informational purposes only. Loanstreet accepts no responsibility for loss that may arise from reliance on information contained in the articles.


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