CHAPTER TWO

AN OVERVIEW OF TAX INCENTIVES AND SMEs IN

MALAYSIA

2.0

CHAPTER DESCRIPTION

This chapter provides an overview of the tax incentives policy in Malaysia, including
the evolution in the promotion of tax incentives in Malaysia and types of tax
incentives granted and the relevant authoritys guidelines in the application and
approval of tax incentives. The chapter also presents basic demographic information
on SMEs establishment, reviews of SMEs policies and programmes, explanation on
the most prominent tax incentives granted to SMEs and finally reviews the
implications of these tax incentives on SMEs performance. As a background chapter,
the detailed narration of Malaysian tax incentives policy provides an insight to what
extent the current tax incentives are significant to SMEs, especially to the homenurtured companies operating in the manufacturing sector in Malaysia.
2.1 MALAYSIAN INDUSTRIAL POLICY

Since its independence in 1957, Malaysia has experimented with a series of industrial
policies.

In Malaysia, industrial policy refers to selective government efforts in

promoting new economic investments via various channels such as trade, credit,
human resource and technology policies (Lall, 1995). From 1970s, the overriding
strategy was the implementation of New Economic Policy (NEP) which intended to
fairly distribute the nations wealth amongst different races in this country. In response
to the racial riots in 1969, the introduction of NEP primarily sought to readdress interethnic socioeconomic disparities and indirectly aimed at the promotion of a wealthy
Malay business community, rather than more effective industrial policies

(Jomo,
2

2007). Other than wealth distribution industrial policy, there are two major types of
industrial policies in Malaysia where each type of industrial policy is characterized by
different objectives.
2.1.1

Import-Substituting Industrialization

Government policies from the late 1950s favored import-substitution industrialization,

with government intervention largely limited to the provision of tariff protection,
infrastructure facilities, tax exemptions and other incentives. Malaysia has executed at
least two types of import substitution policies. The first type of import substitution
policy was targeted at promoting the development of light industries such as food,
paint, and clothing. The second type had focused on the development of heavy
industries like steel and car industries. The purpose of the policy was to promote the
development of manufacturing industries serving the domestic markets (Cassey,
2005). Most of these import substituting industries were set up as subsidiaries of
foreign companies to finish goods produced with imported materials for more
profitable sales within the protected domestic market.
However, there were major drawbacks related to import-substituting industrialization
especially related to rent-seeking when the expenditure of resources in acquiring such
government-endowed rents grew in Malaysia (Edwards, 1975). In terms of location,
most industries were concentrated on the west coast of the peninsular and often smallscale manufacturing businesses were pushed out while regional dispersion was
considered less likely to be profitable. Finally, in 1968, Raja Mohar Committee
proposed the Investment Incentive Act to encourage investments in manufacturing
export goods and this new legislation reflected a strategic switch in emphasis from
import-substitution to export-oriented industrialization (Jomo, 2007).
2.1.2

Export Promotion Industrial Policy

Malaysia has implemented export promotion industrial policy for more than 40 years,
where the effort to promote export-oriented industries had been launched since the late
1960s. The introduction of Investment Incentives Act of 1968, Free Trade Zone Act
1971 and the Promotion of Incentives Act of 1986 have actively promoted Foreign
3

Direct Investment (FDI) in export oriented companies. These policies initially were
aimed at endorsing the development of manufacturing industries serving foreign
markets. Many efforts had been undertaken by the government to entice exportoriented manufacturing companies to set up their businesses in areas such as the free
trade zones (FTZs). FTZs offer financial benefits in the form of pioneer status, which
allows tariff exemption on imports and exports and tax holidays over a period of 5
10 years (companies were exempted from corporate income tax of 35 % and
development tax of 5 %).
Upon expiration of the pioneer status, companies are often granted with investment
tax credits with further tax exemptions for another 5 to 10 years. In some cases where
FTZs could not be established, the companies are allowed licensed manufacturing
warehouses (LMWs) which share similar privileges as companies located in FTZs
(Rasiah, 2002). All the subsidies and incentives offered in the form of tax exemptions
thus served not only to attract investments, but may also induce actual value added to
goods produced by the Malaysian manufacturing sector.
The first IMP (1986 1995) recommended the continuation of the export-led
industrialization strategy but emphasized the promotion of resource-based industries
where Malaysia had already developed a strong foundation with higher local content
and the diversification of the non-resource based industries. This strategy was pursued
through further liberalization of trade and investment, and substantial incentives were
granted to encourage investment and exports. The incentive system under the IMP was
tied to industries in which Malaysia had a comparative advantage and those products
that were of strategic importance to the country and termed as priority products (IMP,
1994).
2.2

HISTORY DEVELOPMENT OF TAX INCENTIVES IN MALAYSIA

After independence in 1957, the government realized that the Malaysian

Industrialization required a conducive environment, thus, during the launching of the
first economic plan, the government allocated RM 115.8 million or 2.5 percent of the
total public development expenditure for industrial and mining development (Said,
2000). This allocation had been increased steadily over the subsequent five year plans
4

and under the Fifth Malaysia Plan (1986 1990), the amount rose to RM 3,149.65
million or 4.56% of the total public development expenditure during the planned
period. A positive step towards accelerating industrial development then was the
establishment of industrial estates which were located at Petaling Jaya. Parallel with
the industrial development, the government started to upgrade the infrastructure
facilities and, apart from the physical incentives, fiscal incentives were given an
emphasis as part and parcel of the overall effort to create a conducive investment
climate to attract specific industries. To further demonstrate the governments concern
in stimulating the investment climate for the investors, the Pioneer Industries
Ordinance was introduced in 1958 where the focus was based on the promotion of
import-substitution industries, such as consumer goods and intermediate goods (Said,
2000). Although, the Pioneer Industries Ordinance of 1958 was successful in
attracting industries, it was inadequate in accommodating the governments wider
objectives, particularly employment creation and income distribution which were
necessary if the country was to industrialize rapidly. Due to the limitations of the
domestic market, especially in the processing of raw materials and scarcity of
domestic capital, thus, greater emphasis was placed on foreign capital, management
expertise, technical know-how and marketing outlets. A shift in policy to attract
foreign investments and export-oriented industries resulted in the Pioneer Industries
Ordinance 1958 being replaced with the Investment Incentives Act, 1968 (IMP, 1994).
According to Said (2000), the introduction of the Investment Incentives Act, 1968 had
increased emphasis on labor-intensive industries, export-oriented industries, industries
utilizing domestic raw materials and the establishment of industries in the less
developed areas of the country. Other than Pioneer Status, new incentives were
offered such as Investment Tax Credit, Export Allowance, Double Deduction of
Expenses Incurred on Promotion of Exports Overseas, Accelerated Depreciation
Allowance, the Increased Capital Allowance and also Hotel Incentives. Over the
years, these incentives were reviewed and improvements were made in line with the
governments development objectives, for example,

in 1971, the Labor Utilization

Relief Act was introduced to promote labor-intensive industries. Thus, this led to the
promulgation of the Promotion of Investments Act of 1986 which is currently the
main legislation for fiscal incentives for manufacturing, agriculture and tourism in
Malaysia.
5

2.3

TAX

INCENTIVES

AND

SMES

IN

THE

MANUFACTURING

SECTORS

In Malaysia, various types of tax incentives are targeted at export expansion and
towards the development of SMEs which are deemed as critical in developing interindustry linkages (Kanapathy 2000). For the manufacturing sector, the two most
important incentive schemes, both under PIA 1986; are the Pioneer Status (PS) and the
Investment Tax Allowance (ITA). The following subsection discusses PS and ITA in
greater detail.

2.3.1

Pioneer Status and Investment Tax Allowance

Under the Promotion of Investment Act (PIA) 1986, the two most prominent tax
incentives for SMEs are Pioneer Status (PS) and Investment Tax Allowance (ITA).
These two tax incentives can be applied to SMEs which are manufacturing promoted
products or are undertaking promoted activities. Generally, a company which has been
granted with Pioneer Status enjoys a five years partial exemption from the payment of
income tax. It only pays tax on the remaining 30 per cent of its statutory income 1 (SI),
with the exemption period commencing from its Production Day, which is defined as
the day when its production level reaches 30 per cent of its capacity. To further
encourage investments, the government gazetted the states of Perlis, Sabah, Sarawak
and designated the Eastern Corridor2 of Peninsular Malaysia as the promoted areas,
which entails all successful applications received from companies located in these
areas to enjoy a 100 per cent tax exemption against their statutory income during their
five years exemption period (PIA 1986).
As an alternative to Pioneer Status, eligible companies may apply for Investment Tax
Allowance (ITA). Pioneer companies are only entitled to this incentive after the expiry
of the pioneer period or if their pioneer status has been withdrawn. In other words the
1 Statutory Income is derived after deducting revenue expenditure and capital allowances from the gross income.
2The

Eastern Corridor of Peninsular Malaysia covers the States of Kelantan, Terengganu and Pahang, and the
district of Mersing in the State of Johor.

ITA is mutually exclusive with the pioneer status. This incentive is also available to
companies carrying out promoted activities or producing promoted products. This
type of incentive is well suited for projects or industries that are capital intensive and
have a long gestation period. A company granted ITA is entitled to an allowance of 60
per cent on its qualifying capital expenditure which includes factory, plant, machinery
or other equipment used for the approved project and the related expenses are incurred
within five years from the date the first qualifying capital expenditure is allowed. The
company can then offset this allowance against 70 per cent of its statutory income for
each year of assessment. Any unutilized allowances can be carried forward to
subsequent years until they are fully utilized. The remaining 30 per cent of the
companys statutory income will be taxed at the prevailing company tax rate (PIA
1986).
Similar with PS, any SMEs granted with ITA located in the promoted areas are also
eligible for an allowance of 100 per cent on their qualifying capital expenditure
incurred within a period of five years. The allowance can be utilized to offset against
100 per cent of the statutory income for each year of assessment.
The greatest challenge for eligible SMEs prior to being awarded with either PS or ITA
is on the criteria stipulated in the Act which require all companies to comply with at
least one of the following criteria:
a)

The value added on the product must be at least 15 per cent, or

b)

The project must contribute towards the socio-economic development of the

rural population.

However, in a meeting with an officer from the Ministry of International Trade and
Industry, (MITI), he stressed that the above criteria are not intended to burden SMEs
as the 15 per cent rate for value added is reasonably low and achievable even if the
SMEs are from the small category. The aim of the government in introducing such
criteria is to prepare SMEs to achieve competitive advantage through the production
of quality products for both domestic and global markets. Application for this tax
incentive should be forwarded to Malaysia Industrial Development Authority (MIDA),
an institution under MITI.
7

PS or ITA is also eligible for SMEs registered under the Industrial linkage Program
(ILP) Incentives. The ILP incentives have been enhanced under the World Class
Program with the aim to encourage SME vendors to produce intermediate goods for
the international market. A PS for 10 years with full exemption on its statutory income
or 100% ITA on qualifying capital expenditure incurred within a five year period with
full exemption on statutory income are granted to SMEs capable of achieving World
Class Standard. In addition, those SMEs under the Basic Program and are producing
the intermediate goods in an approved ILP scheme, may also be granted PS with full
exemption (tax rate of 100%) on statutory income for five years or 60% of ITA on
qualifying capital expenditure incurred within a five year period with full exemption
on statutory income. However, with effect from 13 th September 2003, if companies are
participating in ILP, the 60% of ITA on qualifying capital expenditure may be set-off
against 100% of their statutory income.
The PIA 1986 also provides PS for small scale manufacturing companies, defined as
companies incorporated in Malaysia with shareholders funds not exceeding RM500,
000 and having Malaysian equity of at least 70 percent, as well as manufacturing
products or undertaking promoted activities under the Promoted List for Small Scale
Companies. However, in order to qualify for PS, they need to fulfill at least one of the
following criteria:
a) Products should be used as raw materials or components by manufacturing
industries;
b) Products substitute imports and the local material content is more than 50% in
terms of value;
c) Export at least 50% of their input; and
d) Contribute towards socio-economic development.
Table 2.1 below shows the distribution of total applications and approval of two tax
incentives to SMEs; PS and ITA for the period 1995 until 2000 as reported in SMI
Development Plan (2001 2005). As shown in the table, SMEs are more favorable
towards PS and the contribution of SMEs approved with PS towards potential
employment and capital investment are also higher as compared to ITA. On the other
hand, Table 2.2 highlights the total number of SMEs projects approved with tax
8

incentives according to their ownership status for the year of 1997 until 2007. As
shown in the table, about 1,346 of the SMEs have been approved with tax incentives,
with the highest being awarded to Wholly Malaysian-owned SMEs (851 companies),
followed by Malaysian majority (269 companies) and Wholly Foreign SMEs (113
companies). In addition, the government also granted tax incentives to SMEs with
Foreign majority (95 companies) and Joint Venture companies where the portion of
shares capital are equally owned between the government and foreign investors (18
companies).

TABLE 2.1
Tax Incentives for SMEs for the Period 1995 Until 2000
Year

Applications

1995
256
1996
225
1997
179
1998
140
1999
81
2000
123
Total
1,004
Source: MIDA (2005)

Pioneer Status
Approved Potential
Employment
145
123
104
121
61
61
615

4,409
3,434
2,904
3,103
1,448
2,028
17,326

Capital
Investment
(RM000)
242,978
268,741
274,571
236,607
113,900
228,883
1,365,680

Applications

Investment Tax Allowance

Approved Potential
Employment

19
16
20
13
4
6
78

3
6
9
9
2
1
30

103
202
183
195
27
34
744

Capital
Investment
(RM000)
6,200
13,800
24,888
34,770
4,263
2,074
85,995

TABLE 2.2
SMEs Project Approved with Tax Incentives According to their Ownership
Ownership
Number
Wholly Malaysian
851
Wholly Foreign
113
Malaysian Majority
269
Foreign Majority
95
Joint Venture 50/50
18
Total
1,346
Source: Unpublished data from MIDA (2008)

Employment
23,556
3,168
7,941
2,605
575
37,845

Total Capital Investment (RM)

3,003,940,225.00
664,657,189.00
1,071,675,454.00
324,728,611.00
91,157,231.00
5,156,158,710.00

10

Furthermore, other than these two mutually exclusive tax incentives, SMEs are also
entitled to apply for Reinvestment Allowance (RA) and enjoy the preferential tax rate
of 20 per cent on their chargeable income. The following subsection explains RA and
preferential tax rate applicable to SMEs.

2.3.2

Reinvestment Allowance and Preferential Tax Rate

RA is more commonly known as a second round incentive to companies which have

already enjoyed the tax holiday from either pioneer status or ITA. RA is provided
under Schedule 7A of the Income Tax Act 1967 which states that any resident
company in Malaysia that has complied with the following conditions is eligible for
RA:
a) has been in manufacturing operation for not less than twelve months; and
b) has incurred qualifying expenditures for either expansion, modernization or
automation or diversification of its existing manufacturing business within the
same industry
RA requires no prior approval from MIDA and those companies utilizing the RA will
enjoy a flat rate of 60 per cent exemption on the qualifying capital expenditure
incurred. This 60 per cent RA will be set off against 70 per cent of statutory income
(SI), and if RA exceeds 70 per cent of SI, the unabsorbed RA can be carried forward
indefinitely. On the other hand, if the amount of RA is below 70 per cent of SI, the
amount of RA is credited to an exempt income account (Kwai Fatt 2007). Finally, to
encourage the setting up of a resident company, the government has increased the
chargeable income from RM 100, 000 (until YA 2003) to RM 500, 000 with effect
from Year Assessment 2004 (wef YA 2004) at a preferential tax rate of 20 per cent on
the chargeable income. With effect from YA 2004, a resident company which has a
paid up ordinary shares capital of not more than RM 2.5million (categorized as a
small scale company) is given the preferential tax rate of 20 per cent on the chargeable
income of not exceeding RM500,000.

11

2.3.3

The Process of Application, Approval and Granting the Tax Incentives

Other than the qualification criteria which require eligible SMEs to comply as
stipulated in the Act, the whole process of application, approval and granting the tax
incentives is another barrier which delays the eligible SMEs in their utilization of tax
incentives. Figure 2.1 and 2.2 visualizes the whole process of granting tax incentives
to companies including SMEs. As depicted in Figure 2.1 and 2.2, the application
process of tax incentives is divided into two main stages; the first stage is the process
of application and approval of tax incentives, and the second stage is the process of
awarding the certificate of PS or determining the effective date of ITA. Firstly, both
PS and ITA forms are submitted to MIDA, the principal government agency which is
actively involved in promoting the manufacturing sector. Being the main authority that
leads and monitors the manufacturing sector, MIDA is responsible in assisting the
interested companies to invest in the manufacturing sector, facilitate the
implementation of their projects and evaluate the application of tax incentives for the
investment projects.
MIDA takes an active role in providing advisory services during the companies initial
stage of seeking information on tax incentives and going through the process of
applying for tax incentives.

Such services provided by MIDA include giving

information on tax incentives and assisting the business owners or applicants to fill up
the tax incentives application form accurately. While incomplete forms will be
returned and asked to be resubmitted, the completed application will be processed by
MIDA within 60 days from the date received. The decision either to accept or reject
the application is at the discretion of the Industries Action Committee where a
decision is made according to SMEs eligibility and compliance. Eligible SMEs will
receive the approval letters from Ministry of Finance (MOF) and Ministry of
International Trade and Industry (MITI).
After the first stage of the process is completed, the second stage is the process of
awarding the PS certificate or determining the effective date of ITA. Within 24 months
after the date of approval of the tax incentives, all SMEs that have been approved with
tax incentives must apply for the certificate of PS or determine the effective date for
ITA. At this stage, all approved SMEs must comply with the requirement that their
12

production capacity level have attained 30 per cent. In cases where their production
capacity is below the required 30 percent level, they need to request to defer the
process of awarding the certificate. On the other hand, approved SMEs which have
achieved the production capacity level of 30 per cent will have to submit the
application form to apply for the certificate of PS or the effective date of ITA.
As shown in Figure 2.2, after the PS or ITA has been granted to SMEs, it is assumed
that SMEs will be successful in their utilization of the tax incentives. Such an
assumption is made as MIDA does not have any monitoring process to observe the
suitability of SMEs choice of tax incentives and whether SMEs are successful in the
utilization of tax incentives. The flow charts clearly show that MIDA does not require
any performance reports from the SMEs that have been granted with tax incentives.
Following the detailed discussion on the development of tax incentives in Malaysia,
the subsequent sections provide an overview of the current profiles of the SMEs
business establishments, which include definition of SMEs, challenges faced by the
Malaysian SMEs and the available programs for SMEs development.

13

FIGURE 2.1

Flowchart of the Application And Approval Process of Tax Incentives to SMEs**

SMEs seeking
information on the
investment tax
incentives

MIDA provides advisory

services
and
assists
investors
in
their
applications for investment
tax incentives

If the applicants wish to

reapply for ITI, they can
do so by submitting new
application forms

Forms returned to
applicants

No respond

Applicants
submit application
pleted
form to MIDA

The decision either to

accept or reject will take
into consideration the
criteria of eligibility
complied by SMEs

Receive application
forms and sort by type of
industry

Respective division
screen and check the
application forms

Incomplete

Completed

The completed form

will be processed within
60 days from the date
received by MIDA

Submission of additional information as

Evaluate and tabled in

the meeting
Decision:
Accept or Reject

Letter of rejection is
sent to the applicant

Request to submit
additional
information

requested by MIDA
Accept

Industries Action Committee

(Main Representative): MITI,
MIDA, MOF, IRB and SME
Corp

Reject
APPROVAL

MITI

MOF
14
Send approval letter
to eligible SMEs

Within 24 months
after the date of ITI
approval, the SMEs
must apply for the
certificate

Eligible SMEs
approved with ITI
send application
form to MITI

If the eligible
SMEs do not meet
the
production
capacity level of
30%, they need to
request to defer
the certificate

Fulfil the criteria to

apply for ITI certificate

Awarding eligible SMEs

with ITI certificate

Pioneer Status
Certificate

FIGURE 2.2

Effective Date for

Investment Tax
Allowance

Application Process of the ITI Certificate**

**Note:
This flowchart has been constructed based on the discussion with a MIDAs officer who is
directly involved with the client charter of application and approval of tax incentives. The
researcher took the initiative to draw out this flowchart since there is no simplified visual
flow chart to show the process involved in the application, approval or awarding the
certificate of PS or ITA.

15

2.4

PROFILE OF SMES IN MALAYSIA

SMEs in Malaysia play an important role in the countrys economic development. According
to statistics provided by SMIDEC, in 2005 SMEs accounted for 99.2 per cent or 518,996 of
all enterprises establishments in the manufacturing sector. In Figure 2.3, the distribution of
SMEs in Malaysia by their geographical location shows that most SMEs are concentrated in
Selangor, Kuala Lumpur and Johor comprising a total of 43.3 percent. Perak and Sarawak are
next with 9.3percent and 6.8 percent respectively, while Sabah and Penang have 6.3percent of
total SMEs. SMEs in most of the states are characterised by micro establishments. Of
significance are the states of Kelantan, Terengganu and Perlis where the proportion of micro
establishments are high, making up 91.9percent, 87.9percent and 87.1percent of SMEs
respectively. As indicated in Figure 2.4, the comparison of business establishments between
the two years of 2003 and 2010 shows that the percentage of micro businesses decrease by
1.3percent, and the increase in small and medium-sized companies are by 0.08percent and
0.06percent respectively.
In terms of distribution of SMEs in the business sectors, Figure 2.5 reveals that the service
sector has recorded the highest growth of micro SMEs, while mining and quarrying sectors
have the least number of micro businesses. For the manufacturing sector, the distribution of
micro businesses is 57.1percent, comprising of 36.8percent of small-sized companies and
6.1% of medium-sized companies. Although there is only a small percentage of mediumsized companies in the manufacturing sector; however, they are able to generate the highest
output value worth of RM130,639 million in 2010. This amount also represents the highest
output value compared to other business sectors. In addition, SMEs contributed 32.5 percent
to the Malaysian GDP in 2011 and 57percent of the workforce (at 3.7 million employees)
(SME, 2012).
However, in terms of the export market, Malaysian SMEs share of total exports is only about
20 per cent

lower than many other countries such as the Philippines, Hong Kong, Taiwan

and even the USA (SMIDEC, 2002). The largest concentration of SMEs in Malaysia are
involved in the textile and apparel sector, food and beverages, metals and metals products as
well as wood and wood products. A majority of manufacturing companies in Malaysia are

16

located in the central part of Malaysia and around the countrys major industrial regions
(IMP2, 2005).
The governments commitment and concern for the development of SMEs has been evident
from the early 1970s with the introduction of the New Economic Policy in 1971, which
aimed to improve the peoples welfare and restructure ethnic economic imbalances (Ariff &
Abu Bakar, 2002). Furthermore, the governments commitment to the development of SMEs
can also be seen in the second Industrial Master Plan (IMP2 2005), which ended in 2005, this
is followed by the Third Industrial Master Plan (IMP, 2006) for the years 2006 to 2020,
coinciding with the countrys vision for 2020 (Saleh & Ndubisi, 2006).
In addition, the government has implemented numerous financial and non-financial
incentives with the key intention of enhancing the growth of SMEs. Some examples of the
financial incentives given are grants, conventional loans, venture capital funding and tax
incentives, while

non-financial incentives are in the form of physical infrastructure,

information and training provided by the Government or by trade associations. All these
incentives are mainly provided and coordinated by Government agencies. The main agencies
that offer incentives to SMEs are Malaysia Technology Development Corporation (MTDC)
and Malaysian Industrial Development Authority (MIDA).
In terms of financing, as reported in Malaysia SME (2012), local financial institutions are the
main source of financing for medium-sized companies (51.7percent), while financing from
other sources which includes grants or financing from the government and financing from cooperatives accounts for 28.5percent. Micro and small-sized companies have depended mainly
on their own internally generated funds. Only 17.4percent of micro establishments indicated
that they relied on financial institutions for financing.

17

Selangor

19.5

W.P Kuala Lumpur

13.1

Johor

10.7

Perak

9.3

Sarawak

6.8

Sabah

6.3

Pulau Pinang

6.3

Kelantan

5.9

Kedah

5.8

Pahang

4.6

Negeri Sembilan

3.8

Terengganu

3.5

Melaka

3.4

Perlis

0.8

W.P Labuan 0.3

W.P Putrajaya 0.1
0

10

15

20

25

Source: Malaysia SME (October 2012)

FIGURE 2.3
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

Distributions of SMEs by State

2.4

19.2

20

78.3

77

2003

2010

Micro

Small

Medium

Source: Malaysia SME (October 2012)

18

FIGURE 2.4
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

Comparisons of Business Establishments According to their Sizes

2.1
18.3

6.1

20.6

14.8
38.8

36.8
34.9

28.9

42.1

79.6
57.1

44.5

56.3
19.1

Micro

Small

Medium

Source: Malaysia SME (October 2012)

FIGURE 2.5

2.4.1

Distributions of SMEs According to the Business Sectors

Definition of SMEs

This section reviews the definitions of SMEs from the various literatures. It is important to
understand the definition of SMEs since the nature of SMEs can be understood from how the
SMEs are being defined and their characteristics which can be considered as unique in the
business sector (MacGregor & Vrazalic 2008). There are a number of definitions of what
constitutes SME. Meredith (1994) suggested that any definition of SMEs should include two
components;

first is the quantitative approach which defined SMEs based on their

quantitative characteristics such as a) number of employees, b) sales turnover and c) total

assets; while second, is the qualitative approach which reflects on how the business is
organized and carried out. Mc Mohan et al.(1993) further claimed that based on the
qualitative approach the number of employees is also widely used around the world to define
the term SMEs.

19

Moreover, from the literature reviews, the quantitative characteristics of SMEs vary from
industry to industry and from country to country. For example, an enterprise type of business,
which is considered as small in one industry such as cement manufacturing, may be regarded
as large in another industry such as trading or tourism. Similarly, an enterprise, which is
considered small by USA standards, may be relatively large in other countries such as
Thailand, Malaysia or Vietnam (Nguyen 2001). In addition, this study supports Nguyens
(2001) assertions that between qualitative and quantitative approach, the quantitative
definition of SMEs is more important as it acts as the underlying base for the research
undertaken and aids in gathering the statistical information. Table 2.1 below summarizes the
quantitative definitions of SMEs from different countries as adopted from Nguyen (2001)
with additional information drawn from the literature review:
TABLE 2.3
Summary of the Quantitative Definitions of SMEs

Country
US

Industry/Status
Retailing
Services
Wholesaling

Quantitative Characteristics
Annual sales or receipts not exceeding $2 to $7.5
million, depending on the industry
Annual receipts not exceeding $2 to $8 million
depending on the industry
Yearly sales must not be over $9.5 to $22 million,
depending on the industry
Annual receipts not exceeding $1 million
Average annual receipts not exceeding $9.5million

Agriculture
General
construction
Special
trade Average annual receipts not exceeding $1 or $2
construction
million
Manufacturing
Maximum number of employees may range from
250 to 1,500, depending on the industry
UK
Manufacturing
200 employees or less
Retailing
Turnover 50,000 pa or less
Wholesale
200,000 pa or less
Construction
200,000 pa or less
Mining
25 employees or less
Motor trader
Turnover 100,000 pa or less
Miscellaneous
Turnover 50,000 pa or less
services
Road transportation 5 vehicles or less
Australia
Manufacturing
50 employees or less
General
Turnover not exceeding $500,000
Japan
Manufacturing
Less than 300 employees
Wholesales
Less than 100 employees
Retail and service
Less than 50 employees
South African SME SME
100 200 employees
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Act
(Gordon 2003)

OR
Micro

Egypt

Turnover of five million Rand (US$833,000)

Maximum five employees

SME

1) The number of workers

2) Fixed assets; and
3) Annual turnover (Rizk 2004)

Production sector

Medium size: not exceeding 200 million bath

Small size: not exceeding 50 million bath
OR

Thailand
(Norlaphoompipat
2008)

Medium size: not exceeding 200 employees and

small size not exceeding 50 employees
Trading sector

Service sector

Medium size wholesale not exceeding 100 million

bath and small size not exceeding 50 million bath
Medium size retail not exceeding 60 million and
small size not exceeding 30 million bath
OR
Wholesale medium size not exceeding 50
employees, retail medium size not exceeding 30
employees and small size not exceeding 15
employees
Medium size: not exceeding 200 million bath
Small size: not exceeding 50 million bath
OR
Medium size not exceeding 200 employees and
small sizes not exceeding 50 employees

Adopted from Nguyen (2001)

Since there is no universal definition of SMEs (Meredith, 1994), three commonly used
criteria in defining small and medium businesses are; number of employees, annual sales and
fixed assets (Ibrahim A.B. & Goodwin 1986). In Malaysia, SMEs can be defined according to
their size, number of employees and activity (Sin 2010). According to Saleh and Ndubisi
(2006), definition of SMEs in Malaysia fall into 2 broad categories:
1. Manufacturing, manufacturing-related services and agro-based industries
Full-time employees not exceeding 150; or
Annual sales turnover not exceeding RM25 million
2. Services, primary agriculture and Information and Communications Technology (ICT)
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Full-time employees not exceeding 50; or

Annual sales turnover not exceeding RM5 million

However, for the purpose of this study, the criteria for defining SMEs have been adopted
from the Small and Medium Industrial Development Plan in manufacturing and
manufacturing-related services in Malaysia.
TABLE 2.4
Definition of SMEs in Malaysia

Small Enterprise
Manufacturing,
Manufacturing
Related Services and
Agro-based industries

Medium Enterprise

Sales turnover between Sales turnover between RM10

RM250,000 and less than million and RM25 million OR full
RM10 million OR full time time employees between 51 and 150
employees between 5 and 50

Source: SMIDEC 2005

2.4.2

Challenges Faced by Malaysian SMEs

According to SMIDPs 2001 to 2005 reports (SMIDEC, 2002), a majority of SMEs

comprising 76 percent of all establishments in the manufacturing sector are small companies.
At present, these companies are still confronted with a number of basic issues related to
market access, low technological capability, shortage of labor and skills, reluctance to
relocate to designated industrial sites, shortage of financing as well as lack of general
awareness of the incentives. In a study by Saleh and Ndubisi (2006), they observed that
Malaysian SMEs are still facing challenges either at domestic level or in the global market
which could hinder their resilience and competitiveness.
Their study also listed all the challenges faced by SMEs. They are as follows:
a) Ongoing difficulties in obtaining funds from financial institutions and the government.
Usually the interest charged by financial institutions on loans borrowed by SMEs is
high, and this is compounded by a lack of financial transparency by SMEs.
b) A lack of human capital is the most significant challenge facing Malaysian SMEs. It is
often too expensive for SMEs to employ a professional and competent workforce.

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c) SMEs face a high level of international competition; this includes from AFTA member
countries and competition from MNCs or new competitors (for example from China
and India).
d) A lack of access to better technology and ICT which hinders more efficient and
productive business operations.
e) A high level of bureaucracy in government agencies inhibits efficient SME business
development operations.
f) A low level of research and development expenditure.
g) A substantial orientation towards the domestic rather than international market place.
Recently, as reported in SME Annual Report 2008, due to world predicaments such as the
global economic and financial crisis, to a larger extent this phenomenon adversely impacted
Malaysian SMEs, especially those in the manufacturing sector. SMEs were negatively
impacted in terms of their production, profit margins and new orders due to reductions in
demand for their products and services, delays in payment collection, funding issues and high
cost of raw materials (Council, 2008).
In order to mitigate the problems, the government has initiated many policy measures for the
benefit of SMEs. These policy measures addressed several key areas of concerns which
include easing the financial burden and assisting companies to restructure loans, reducing the
cost of doing business, enhancing capacity building and assisting specific vulnerable groups
to increase resilience and to better weather the current economic challenges (Council, 2008).
2.4.3

Enhancing the SMEs Development

The governments policy aspirations for SME development are embodied in the IMP3 and the
Ninth Malaysia Plan (9MP). The National SME Development Council (NSDC) is an
important platform established in 2004 to chart the overall policy direction and strategy for
SME development. One of the key outcomes of this Council is the Annual SME Integrated
Plan of Action (formerly known as the National SME Development Blueprint), to enhance
tracking and alignment in the implementation of the programs undertaken by the various
Ministries and Agencies involved in SME development (Council, 2008). The NSDC is
chaired by the Prime Minister, and comprised of members who are Ministers and Heads of
key Government Agencies involved in SME development. Specifically, the Council is
entrusted with the following responsibilities:
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Formulating overall broad policies and strategies to facilitate the development of SMEs
across all economic sectors;

Reviewing the roles and responsibilities of Government Ministries and Agencies

responsible for SME development;

Enhancing cooperation and coordination, as well as guiding stakeholders to ensure the

effective implementation of SME development policies and action plans;

Encouraging and strengthening the role of the private sector in supporting the overall
development of SMEs; and

Emphasizing the development of Bumiputera SMEs across all sectors of the economy.

Other than NSDC, Malaysias New Economic Model (NEM) unveiled on 30 March 2010 is
another economic plan geared to generate the per capita income in Malaysia to more than
double by 2020. In summary, this program aims to shift affirmative action from being
ethnically-based to being need-based hence becoming a more competitive, market and
investor friendly economy. Moreover, for the private sector, NEM is empowered to reduce
fiscal disparity between the wealthiest and poorest of Malaysians. NEM also provides
capability and capacity building programs for SMEs in the Bumiputera Commercial and
Industrial Community (BCIC). Moreover, it offers ongoing support to successful Bumiputera
companies to expand through partnerships with the business community, including the
GLCs, with a view to raise the performance of the entire BCIC. These capability and
capacity building programs focus on building talent, identify new technologies and enhance
collaboration between bumiputera and non-bumiputera companies as well as with MNCs
(NEAC 2009).
2.5

Summary
To summarize, this chapter is divided into two parts; the first part presents the overall views
related to the promoted tax incentives for SMEs in the manufacturing sector which include
types of tax incentives available and the process of application and granting of the tax
incentives. The second part provides the profile of SMEs in Malaysia and covers issues with
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regards to SMEs business establishments, challenges faced by the SMEs in order to survive
and a brief explanation on the SMEs development programs. It also details the governments
aims of assisting SMEs to gain a more competitive advantage in response to globalization as
well as to help SMEs to be more successful in the future.
From the reviews of the SMEs business establishments, it is important to note that SMEs
account for more than 90percent of the total business establishments in Malaysia, which
suggests their vital role in the nations economic development and can be seen from their
ability to establish critical linkages in the global supply chain, strengthen industry cluster
formation and increase domestic value added.
The government has already initiated various programs in the form of fiscal and non-fiscal
assistance to SMEs since these companies are constantly confronted with various challenges
to develop or penetrate the global markets. One of the essential fiscal policies which continue
to provide support to SMEs is the granting of various types of tax incentives to eligible
SMEs, especially in the manufacturing sector. To qualify for tax incentives, SMEs need to
fulfil many eligibility criteria prior to application of tax incentives. However, the current
profit-tax based tax incentives are seen to have a negative impact on the SMEs with losses
incurred during the global economic crisis severely impacting their ability to utilize the tax
incentives granted.
Hence, this study will investigate the impact of the current tax incentives on the performance
of SMEs in Malaysia focusing particularly on the manufacturing sector. The utilization of tax
incentives is likely to depend on the strength of the companies financial characteristics in
utilizing these tax incentives. Therefore, this involves the examination of the financial
characteristics difference between successful and unsuccessful SMEs in the utilization of tax
incentives.

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