1% Prepayment Tax on Income/Minimum Tax on Turnover

We understand Prakas No. 597 on “the Recognition and Tax Obligation regarding the supply of Goods and Services made by an Agent on behalf of a Principal” (Prakas 597) issued in June 2018 was intended to reduce tax burden for distributors by taxing their commissions only instead of sales or turnover. We support this objective to modernize and streamline the tax system, while supporting critical players in the value chain. However, in practice the existing fiscal framework does not effectively reduce the tax burden of distributors and retailers because:

• Manufacturers and importers must voluntarily adopt agent-principal as their business model. This is unlikely because manufacturers/importers have thousands of small and medium wholesalers and outlets as customers. Registering these wholesalers/outlets as agents is not commercially practical due to additional requirements in stock management and POS system for issuing invoices at each agent, that lead to a heavier administrative burden and cashflow issue due to slower inventory turnover and sales.
• Distributors/wholesalers/retailers selling various products from different manufacturers and importers have to obtain separate agent licenses, use separate POS systems, have separate stock controls for each product that they sell on behalf of different principals (importer & manufacturer).

Currently, distributors are disadvantaged and bear heavier tax burden than agents because 1% Prepayment Tax on Income (PTOI)/minimum tax is taxed on distributors’ sales or turnover. If their operating profit margin is between only 2% – 5%, they’ll end up paying 1% PTOI or minimum tax higher than Corporate Income Tax (CIT).  This undermines the principle to align taxes to taxpayers’ ability to pay.

Not double but triple and quadruple taxation on the same tax base:

For example, a manufacturer/importer sells a product at $10 excluding VAT to distributors. Distributors mark up 1$ as their margin and resell at $11 excluding VAT to smaller wholesalers. Wholesalers mark up 1$ as their margin and resell at $12 to drink shops and small outlets. These outlets mark up $1 and sell to final consumers at $13.

1% PTOI tax implication based on the above scenario:

• Manufacturer/Importers 1% PTOI/minimum tax payable: $10 x 1% = $0.10
• Distributors 1% PTOI/minimum tax payable: $11 x 1% = $0.11
• Wholesalers 1% PTOI/minimum tax payable: $12 x 1% = $0.12
• Outlets/drink shops 1% PTOI/minimum tax payable: $13 x 1% = $0.13

Prakas 638 MEF.PrK dated 4 July 2017 on the Criteria for Incorrect Accounting and Procedures for Minimum Tax Payment:

Overall, this Prakas provides criteria for minimum tax exemption, but the 1% PTOI is still imposed on turnover, so there is little to no economic benefit for distributors to go through a rigorous application process to obtain the minimum tax exemption.

Based on the above, the profitability of each distributor down the value chain is lower due to 1% PTOI even if they have the same gross margin, posing an ever-increasing pressure on smaller businesses. Distributors/wholesalers/retailers need to stock inventories, which have additional costs including insurance, stock aging and expiration, and cashflow, unlike agents who have no stock ownership, so operating costs of being a distributor are even higher than agents, but they end up paying a higher 1% PTOI/minimum tax than agents.