GST - a consumption tax

KPMG has produced a lucid piece that describes the impending GST regime for Malaysia:

Our Prime Minister, in his maiden National Budget speech on October 23 2009, had announced that the government was in their final stage of completing its study on the proposed implementation of a Goods and Services Tax (GST) system in Malaysia.

After much anticipation, this week, the Prime Minister further announced that a proposed bill to introduce GST will be tabled in Parliament at the end of the present Dewan Rakyat sitting. To allay concerns that the GST will unnecessarily burden the rakyat, the Prime Minister has re-assured the rakyat that GST will be introduced gently and at a rate that would not burden the poor or the middle-class.

Falling into the family of indirect taxes, the GST is intended to replace the Malaysian service tax and sales tax. This article seeks to provide a general illustration of the principles and mechanics of a GST system.

It is assumed that the Royal Malaysian Customs would be the authority in charge of administering the GST.

The GST, also known as a consumption tax, is a tax levied on supplies of goods and services. To the man on the street, it is incurred only when money is spent.

If no consumption occurs, no GST is suffered by the individual. This can be contrasted with an income tax which is payable when income is generated.

Hence, some have viewed the GST as a more equitable means of collecting revenue for the government as it matches the tax with the ability to pay.

A number of countries including Singapore, Thailand and Australia, have already adopted a similar type of indirect tax.

The mechanics of GST are similar to the value added tax in the UK and Europe, so this tax although new to Malaysia has an established place on the world tax scene.

Mechanism of GST

Conceptually, GST is imposed on the value added to goods or services by each separate processor in the production and distribution chain.

The value added is the value that a producer (whether a manufacturer or distributor, etc) adds to its raw materials or purchases before selling the new or improved product or service.

Upon selling the product or service, the manufacturer or distributor will include a charge for GST at the relevant rate on the value of the supply made.

The manufacturer or distributor will pay the GST collected on its sales (also known as output tax), to the Royal Malaysian Customs, but after deducting the GST it suffered on its purchases (also known as the input tax). And the cycle goes on.

Hence, in reality, GST is a multi-stage tax on the increase in the sales price of the goods or services as they pass through the chain.

The consumer ultimately bears the burden of the tax. This can be seen in the simple illustration chart (right).

Input tax and output tax

In order for a taxpayer to impose GST, the taxpayer must be registered with the Royal Malaysian Customs.

There will generally be a minimum threshold (e.g. based on turnover) before a taxpayer is required to charge GST. The registered taxpayer would be required to submit periodic GST returns. If the output tax is greater than the input tax, the taxpayer will have to pay the excess.

Conversely, if the input tax is greater than the output tax, the taxpayer could seek a refund from the Royal Malaysian Customs.

GST rates and taxable supplies

It is envisaged that not all goods and services will be subject to GST. In the UK for example, there are four types of supply for GST, namely standard rate (15 per cent), zero rate (0 per cent), exempt supplies as well as the reduced rate (5 per cent).

The table above shows an example of the four classifications of supplies in the UK:

It is important to know what category the supplies fall in. This is because where a registered taxpayer is supplying standard rated or zero-rated supplies, the registered taxpayer will be able to claim an offset for input tax suffered on supplies it acquired. However, if the registered taxpayer's supplies are exempted, the taxpayer will not get a refund on the input tax suffered.

Similarly, the taxpayer's customer will not have any input tax to set off against its output tax. This may be an important factor in determining the business competitiveness of the taxpayer.

What can be expected next is the release of the GST Bill. However, as GST is industry-based, there would be accompanying Regulations to implement the system effectively and these regulations are likely to be quite extensive.

It would be interesting to see the various rates of GST and the extent of the taxable supplies. And as everybody will be affected, it is important to understand not only how the system works but what actions need to be taken in the run up to GST.

Running through the checklist below could be a good starting point.

Getting prepared for GST

Checklist for businesses:

* Check whether you need to register for GST

* Check whether you need to register for GST* If yes, what are the compliance requirements

* If yes, what are the compliance requirements* Prepare a costing/ pricing analysis as well as pricing strategies

* Prepare a costing/ pricing analysis as well as pricing strategies* Notify your customers/ suppliers on your GST status

* Notify your customers/ suppliers on your GST status* Update your invoices

* Update your invoices* Educate your staff

* Educate your staff * Check IT capabilities

* Check IT capabilities* Review long-term contracts

* Review long-term contracts

Checklist for final consumers:

* Check whether the goods and services you consume are taxable and the relevant rates

* Check whether the goods and services you consume are taxable and the relevant rates* Price of goods and services post-GST may or may not change. Hence plan your budget wisely

* Price of goods and services post-GST may or may not change. Hence plan your budget wisely

Clearly, preparation for the implementation of GST is essential for businesses and at the same time understanding the implications of GST on consumption is vital for consumers.

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GST likely in 2011 or 2012

The Malaysian government is expected to table the draft of the Goods and Services Tax Bill in Parliament on December 17. The Goods and Services Tax ("GST") is a consumption tax which is also called a valued-added tax in other jurisdictions.

The GST is regarded by economists as an efficient tax mechanism due to its broader base of tax reach.

Some analysts expect the actual implementation of the GST in Malaysia to take place in 2011 or 2012. It is also expected that there will be a reduction in the top-tier personal income tax to ameliorate the effect of the GST. There is also likely to be significant transactions that are exempted from the GST to avoid burdening lower-income groups.

There is some concern about the efficiency of GST refunds, which is a key feature of value-added tax regimes in other jurisdictions.

Here is the report from the Business Times:

The goods and services tax is likely to be near term revenue neutral and could be accompanied by personal income tax cuts to avoid political backlash, says an economist

MALAYSIA may eventually implement the goods and services tax (GST) although analysts say it is more likely to happen either in 2011 or 2012.

They said the government is expected to study all aspects before introducing the tax.

"This is because GST is a regressive tax hitting the lower income group the most, so (it) can be politically unpopular," economist Kit Wei Zheng said.

He was commenting on a news report quoting Prime Minister Datuk Seri Najib Razak in New York as saying that the first reading of GST proposal will be tabled during the current parliamentary session.

He thinks the GST is likely to be near term revenue neutral, as it would be replacing sales tax and could be accompanied by personal income tax cuts to avoid political backlash.

"The fiscal benefits from GST implementation would be felt more in the medium term, with immediate benefits far less visible," he said.

He added that the government has already hinted it is in the final stages of completing a study on the GST implementation and that the rate would be lower than the sales and services tax rates while exemptions would be granted to lower income groups.

The cabinet decided at its meeting last week for the tabling to allow for discussions and feedback from the public.

Najib had said that if the government decides to implement the tax, it would at a rate that will not burden the poor or the middle class.

Najib also said the rate for the proposed GST may be less than the current sales and services rate of between 5 per cent and 10 per cent.

Standard Chartered Bank economist Alvin Liew said the decision to look at the GST is definitely a move in the right direction.

"The timeline for this to happen may not be in 2010, maybe more likely in 2011 when growth becomes more entrenched," he said.

RPGT: Possible computation workings

Below is an article by Dr Choong Kwai Fatt that attempts to explain the manner in which the new RPGT (Exemption Order) 2009 is to be calculated. The drafting of the Order is still a matter of vigorous debate by Malaysian lawyers. Nonetheless, Dr Choong has offered his considered views on the matter:

Exemption order an interim measure to a complete RPGT system

IN Malaysia, real property gains tax (RPGT) is imposed with the intention to curb property speculations. It is imposed on the gains on disposal of Malaysian landed properties and the rate varies from 5% to 30% depends on the holding period.

With effect from April 1, 2007, the Government decided to exempt RPGT in view of the economic slowdown and it was aimed at assisting property developers in disposing of their houses, and spearheading the economic progress.

Prime Minister Datuk Seri Najib Tun Razak, who is also Finance Minister, on Oct 23, however, reintroduced RPGT to put in place a fair administration of taxes.

In a nutshell, an equitable system will now be in place as income tax are imposed on income derived by any person in Malaysia while RPGT, on capital gains on disposal of landed properties. There will not be any loss of revenue to the Government.

In the Budget 2010 speech, the Government’s intention was clear. It is to ensure that the Malaysian tax system is equitable and continue to be able to generate revenue for development purposes. In line with this, the Government proposed that a tax of 5% be imposed on gains from the disposal of real property from Jan 1 2010. Any agreements signed between now till Dec 31 remains RPGT exempted.

Finance Minister II Datuk Seri Ahmad Husni Mohamad Hanadzlah then, exercising his power under section 9(3) of the Real Property Gains Tax Act 1976 (RPGTA), gazetted Real Property Gains Tax (Exemption) Order 2009 which will take effect from Jan 1, 2010. A fixed RPGT rate of 5% on gains from property gains is achieved through the application of this exemption order.

Malaysian individuals are accorded tax exemption of 10% of the chargeable gain (CG) from the computation of RPGT3. Thus, this would effectively mean that they will be paying less than 5% of RPGT rate while companies continue to pay 5%.

The RPGT Exemption Order exempts any person from the application of Schedule 5 of the RPGTA on the payment of tax on the CG arising from any disposal of assets on or after Jan 1, subject to the condition that the amount of CG exempted shall be determined in accordance with the following formula: A/B x C where:

A = Tax on CG at the appropriate tax rate reduced by the Tax on CG at 5%;

B = Tax on CG at the appropriate tax rate;

C = Amount of CG

Effectively, the exemption formula can be simplified as follows:

Chargeable gain x (Appropriate rate – 5%) / Appropriate rate

The appropriate tax rate to be applied on this exemption order depends on the holding period of the property which is summarised as per Table A.

Illustration: Malaysian citizen individuals

Chia Lat acquired a condominium in Bangsar for RM500,000 on Jan 1, 2008. On March 31, 2010 he decides to dispose the property for RM780,000. The RPGT to be paid by him would be as per Table B.

Illustration: Companies

Using the same example as above, and assuming the taxpayer is a Sdn Bhd, the RPGT payable would be as per Table C.

Mathematical confusion

The mathematical formula stipulated in the RPGT exemption basically restores to the fact that the RPGT is 5% on the CG. This is the mathematical equation:

Assuming the appropriate tax rate is y and CG is x, then the RPGT payable after the RPGT exemption would be :

[x – x(y - 5%)/y ] y =xy – xy + 5% x

= 5% of x

The Government has stated that the purpose of the RPGT is to have a fair administration of taxes. Thus the exemption is an interim measure to begin with RPGT of 5% taxes. In years to come, once the exemption order is revoked, RPGT payable would revert to the original position, ranging from 30% to 5%, depending on the holding period.

Policy reform: Currently, taxpayers are only required to keep accounting records for seven years under the law. It may not be feasible to impose 5% on the chargeable gain on gains derived from holding periods more than seven years. This would mean tax payers are required to keep their accounting records for an indefinite time to justify cost attributable to the acquisition.

It is therefore suggested that the Government impose 2% on selling price instead of holding periods exceeding seven years or as in the past, exempt these gains from RPGT. After all, the underlying purpose of RPGT is to curb speculation of properties rather than tax collection.

Moving forward, the Government may likely further align the taxes on landed transactions to be equitable with the income tax system. Therefore, it is crucial that the rakyat understand the Government’s overall objectives and appreciate that this exemption order is an interim measure to prepare the country for a complete restoration of the RPGT system when the time comes.

Once the country’s economy is paced and sustaining desired growth, this exemption may likely to be revoked and property gains will be back causing gains will be taxed at the appropriate rate.

Till then, this exemption order will continue to allow us to enjoy most of our short-term trading gains from real property transactions.

Case Digest: Thor Eagle Maritime Agencies v Innovest Bhd

The recently reported case of Thor Eagle Maritime Agencies v Innovest Bhd [2009] 6 MLJ 74 decided by the High Court in Kuala Lumpur dealt with the features of contracts of affreightment that is instructive for the shipping, logistics and transportation industry.

The case involved a customer that had entered into a contract of affreightment with the shipping line, via a shipping agency, to carry goods.

The time of shipment stated that the date of arrival of the ship would be "about" 10-15 August 1998.

The ship actually arrived on 16 August 1998.

About one week prior to the date of the ship's arrival, the client had communicated clearly to the shipper that it wished to repudiate or terminate the contract.

The facts of the case suggest that the client's act of repudiation or termination was not effective. The court did not deal with the matter. So, we are not able to see why the repudiation by the client was not effective.

The issues before the High Court were:

1. Whether time was of the essence in that contract of affreightment. If it was found that time was of the essence, the client would not be liable to the shipper; and

2. Whether the shipper had made any effort to mitigate losses from the repudiation. If there were no efforts to mitigate, the client's liability would be reduced.

Whether time was of the essence
The High Court relied on 3 matters in ruling that time was NOT of the essence in that case.

a. The contract of affreightment did NOT specifically state that time was to be of the essence in the contract.

b. The contract merely stated that the date of arrival of the ship was "about" 10-15 August 1998.

c. There were previous occasions in dealings between the client and the shipper where the client had proceeded to load the goods even though the ship had arrived later than the scheduled dates.

The High Court made the following observation:

It is trite that in contracts relating to shipping, time may not be of the essence and it all depends on the terms of the contract, intention of parties, custom, practice etc.

Mitigation by the shipper
As with the laws of contract of most nations, Malaysian contract law required the shipper to make an effort to mitigate or reduce its losses from the cancellation of the contract by selling the cargo space to other clients.

In that case, the shipper did not offer any proof that it had attempted to mitigate its losses.

As such, the shipper's claim of USD256,760-00 was reduced to USD80,000-00.

FRS 139 and its bearing on transfer pricing

As if transfer pricing per se is not complex enough, by January 1, 2010 there will be an added factor that involves fair value accounting which is also known as the "mark-to-market" rule.

Since transfer pricing compliances are very much driven by collating data on comparable activities and products provided by competitors within the same jurisdiction - a process that is already difficult in and, of itself, fair value accounting will mean that applicants may have even higher standards of proof.

This Ernst & Young piece is instructive:

COME Jan 1, the Malaysian Accounting Standards Board’s Financial Reporting Standard 139 – Financial Instruments: Recognition and Measurement (FRS 139) will finally be implemented in Malaysia. Four years since its implementation date was set, it is still considered uncharted waters for many corporations. This is not surprising since FRS 139 is considered the “mother” of all standards by some.

Under FRS 139, many financial assets and financial liabilities are required to be carried at fair value. This will have a significant impact on loans between related parties, which generally can be interest-free or carry interest rates which are well below the market rates.

The definition of fair value under FRS 139 is “the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction”. Paragraph 48A of FRS 139 further states that “The best evidence of fair value is quoted prices in an active market ... Valuation techniques include using recent arm’s length market transactions between knowledgeable, willing parties, if available ... ”

Interestingly, it loosely echoes the Organisation for Economic Cooperation and Development’s guide for an arm’s length interest rate:

“... an arm’s length interest rate shall be an interest rate which was charged, or would have been charged, at the time the financial assistance was granted, to uncontrolled transactions with or between independent persons under similar circumstances.”

It could well imply that the measurement of related party loans initially at their respective fair values and subsequently at amortised cost using the effective interest method, may be deemed to be in line with the arm’s length principle since market interest rate is used.

Following the introduction of Section 140A of the Income Tax Act 1967 (ITA) which basically requires taxpayers to ensure that their related party transactions are carried out at arm’s length, would this then mean that an assessment of the fair value of related party loans by the auditors under FRS 139 can serve as contemporaneous documentation for transfer pricing purposes?

The corporate taxpayers do not have an option as to whether to accept the fair value accounting treatment in their financial statements – it is a requirement of FRS 139 and also the Companies Act 1965.

Further, requiring corporations to measure related-party loans initially at their respective fair value may not only affect the income statement. However, for certain, the subsequent amortisation amounts, measured at amortised costs, will represent accounting interest income or interest expense in the income statement. Book entries are generally not the actual receipts or payments, and in tax terms are not real costs or income earned.

At this point, it would be helpful to look at what other tax jurisdictions have done under similar circumstances. Hong Kong, Singapore and New Zealand tax authorities have issued departmental interpretation and practice notes on the income tax implications arising from the adoption of IAS 39 or its local equivalent.

While in general most tax authorities require the tax treatments to follow or be consistent with the accounting treatment under FRS 139 as far as possible, they also acknowledge that the revenue versus capital consideration would need to be considered in determining the tax treatment.

As an example, in Singapore, the tax adjustment is such that the discount on the interest-free loan recognised in the income statement will not be allowed as a tax deduction and the interest income recorded will not be taxed because these are merely book entries.

The auditor’s primary role is still that of expressing an opinion as to the true and fair view of the financial statements. This means that corporations would still need to provide auditors with supporting evidence of the fair value of the related-party loans to enable auditors to express an opinion.

The fair value measurement rests on the rebuttable presumption that effective interest rates used in the amortised cost method is the market interest rate and is thus, at arm’s length. While this is generally true, loan arrangements made with unrelated parties in the current business environment should be considered as arm’s length, although they may not carry the same market interest rates due to various factors such as level of credit risks, tenure, size of collaterals, etc.

So, what would corporations provide to the auditors? Section 140A of the ITA provides that the acquisition or supply of property or services with related parties be conducted at arm’s length, failing which the Director General of Inland Revenue may adjust the transfer prices.

Since 2003, transfer pricing guidelines have been issued, setting out the extent of information required in a transfer pricing report. The guidelines also stipulate that it is a pre-requisite that a comparable analysis (benchmarking) be carried out to substantiate the arm’s length pricing.

To ensure that corporations provide auditors with the correct arm’s length and market rate interest for related-party loans in the FRS 139 measurement of fair value, it is very likely that a comparable analysis would need to be carried out. This should then provide the setting not only for the auditors but for the tax authorities in support of the argument for arm’s length. Any fair value book entries put through the financial statements should then be met with minimum queries from the tax authorities.

Abolition of Foreign Investment Guidelines in Malaysia

This is a re-cap from the liberalisation of Malaysian investment policies earlier in 2009. This is extracted from Maybank Investment:

Market-friendly Initiatives on corporate equity ownership. PM Najib’s abolition of FIC guidelines and other directives for GLCs, and capital raisings will mark him as one of the most market-friendly Malaysian prime ministers. We believe the changes would benefit commercial REITs, potentially raise interest in Sime and a handful of other stocks, and in the long-term, attract foreign direct investments.

The abolition of Foreign Investment Committee (FIC) rules for all corporate equity transactions and most property transactions could become a hallmark of Najib’s premiership. Foreign REIT managers would now have greater reason to enter and eventually list REITS on Bursa, while a major shareholder who had wanted to raise his shareholding may now do so more easily. Foreign ownership restrictions imposed by ministries / regulators remain in key sectors such as telecoms, water, energy, media.

GLCs to be further transformed. PM Najib has also instructed Government-linked companies (GLC) on two market-friendly moves: (i) government shareholdings in GLCs to be reduced to aid market liquidity and free-float, (ii) GLCs to dispose non-core assets. Both moves will render GLCs more attractive investments although it could initially dampen appetite for their shares. The moves would also benefit the investment banking community with more corporate deals.

Property, by comparison, was a sideshow. The FIC guideline changes to corporate equity ownership and equity raisings, and potential GLC activity, may well have a greater impact on the capital market than on physical property. In particular, individuals states may continue to impose conditions or require consent for foreign property ownership, frustrating foreign investements.

Table 1: Summary of Reforms

Reforms	Key measures
FIC deregulation	FIC guidelines on acquisition of interests, mergers and takeovers repeated with immediate effect FIC will no longer process share transactions nor impose equity conditions on such transactions
FIC approval on acquisition of properties	FIC will only process transactions involving dilution of Bumiputera and Government interests. Even then, FIC approval is only required for properties > RM20m All other transactions (e.g. transactions between foreigners and non-Bumiputeras) no longer require FIC approval
Corporate equity ownership	30% Bumiputera equity requirement during IPO is removed* SC, as sector regulator, will continue to impose at least 25% public spread requirement Bumiputera allocation of IPO shares to be 50% of public spread requirement No equity condition imposed on equity raisings post IPO except for RTOs and backdoor listings
Ownership in services industry	Wholesale segment of the fund management industry fully liberalized to allow 100% ownership Foreign shareholding limits for retail unit trust management companies and existing stock broking companies raised to 70% from current level of 49% BNM and SC will review all visa applications for the financial services industry and capital market respectively

5% RPGT: A prelude to full re-imposition?

One of the country's prominent tax practitioners believes that the revival of the RPGT by imposition of a 5% tax on capital gains on property transactions is a prelude to the full reintroduction of the previous RPGT regime. Here is an extract of the report in StarBiz:

The Government’s proposal to impose a real property gains tax (RPGT) of 5% from Jan 1 may just be a temporary measure, says Taxand Malaysia Sdn Bhd managing director Dr Veerinderjeet Singh.

“We feel that it is a temporary imposition. We think that in the long term, the original scale rates of 30%, 20%, 15%, etc will be coming back,” he told a press conference prior to a seminar on Budget 2010 jointly organised by Taxand and the Malaysian International Chamber of Commerce and Industry (MICCI) yesterday.

Interest Schemes in Malaysia

The Malaysian Companies Act offers an interesting alternative for plantation owners to gain access to investment funds. This is an alternative to conventional funding methods such as bank loans or being publicly-listed. This avenue should be of particular interest to plantations that are starting-up or undergoing a major replanting programme.

The first-ever Agricultural Investment Scheme ("AIS") approved by the Companies Commission of Malaysia ("CCM") is the Country Heights Growers Scheme ("CHGS") promoted by Tan Sri Lee Kim Yew, the creator of the upmarket gated communities of Country Heights in Kajang and Damansara and, the Mines Resort City.

After extensive research into AIS programmes in Australia, Canada, Scotland and several other countries, our law firm was able to conceptualise and present a concept paper on behalf of CHGS for CCM's consideration and approval.

CHGS established 40,000 investment units known as Growers Plots. The scheme was launched in March, 2007 and to-date, the takeup rate has been so phenomenal that more than 80% of available Growers Plots have been subscribed for.

With the success of the pioneering CHGS, plantation owners are now able to consider AIS as a fundraising option.

AIS gives plantation owners direct access to a ready pool of investors who are interested in a direct investment in the oil palm sector. An investor may invest in shares of a listed plantation company, which offer returns in the form of dividends and, gains (or losses) in the movement of share prices. The risks and returns are obvious to all. AIS, however, offers a steadier, yet attractive, rate of return which should appeal to risk-averse investors.

AIS is similar to a closed-end fixed yield instrument. This is one of the key features of CHGS. The annual yield payable to the investor is a range of percentages between 6% to 12% of the initial investment sum which is linked to the annual average price of crude palm oil ("CPO") published by the Malaysian Palm Oil Board ("MPOB").

The yield computation formula is designed to achieve 2 things:-

• It is easy for the investor to monitor his/her expected returns for the year.
• It is an objective formula i.e. not dependent on the operational efficiency of the plantation.

The added sweetener is that there is a bonus feature in that additional yields will be paid to the investor based on the actual tonnage of fresh fruit bunches ("FFB") harvested by the plantation.

AIS is an agricultural investment model that has arrived in Malaysia. It is worthy of consideration by plantation owners seeking access to investment funds for starting-up plantations or replanting programmes. To have a better idea of the AIS-model have a look at CHGS at http://www.chgs.com.my/.

RPGT: Real Property Gains Tax 2010

The Malaysian Government has decided to revive the imposition of the RPGT with effect from January 1, 2010.

Poon Yew Hoe of the accounting firm of Horwath has offered a perspective of the re-imposition of RPGT that should serve as a useful reference for property owners who plan to sell their properties in the near future. His views are extracted from StarBiz:

It may be possible by transferring properties to a company, but there are many pitfalls to consider

AT the recently concluded budget seminar of our firm, a major focus of the 650 attendees was the proposed real property gains tax (RPGT) of 5% to be imposed on disposals of property after Jan 1.

Resigned to the inevitability of the tax and the futility of objections, the ingenious ones posed the question to us on the possibility of tax minimisation by transferring their current properties to a company before Jan 1.

The plan calls for properties which were acquired many years ago at a cheap price (say RM1mil) to be transferred to a company controlled by them at the prevailing market price (say RM3mil).

The transfer will be effected before Jan 1, thus attracting no RPGT on the disposal.

In the future when the property is disposed off by the company, the company will only be taxed on the capital gain over and above the new cost of RM3mil.

If the disposal price by the company is RM4mil, the company will only pay tax on the capital gain of RM1mil (RM4mil less RM3mil) at the rate of 5%, thus resulting in RPGT of RM50,000.

A very ingenious idea indeed. The comparison of taxes payable shows a tax saving of RM100,000 calculated as seen in the table.

Before anyone embarks on such a potentially lucrative move, one has to bear in mind many of the pitfalls, some of which are discussed below.

Date of disposal

For the purpose of this discussion, the term “chargeable assets” is used to refer to properties and other assets that can be caught under RPGT.

Chargeable assets include shares in real property companies which are companies that predominantly hold assets in the form of properties or shares in other real property companies. Only chargeable assets disposed on Jan 1 or after will be assessed to RPGT. Those disposed of from April 1, 2007 to Dec 31, 2009 will not. A day is literally night and day for tax purposes!

But the term “disposal date” has a technical definition and it is not the date when the sales price is paid over as we usually consider a sale to be. In sales circles, as they say, a sale is not a sale until the money is collected!

However, for RPGT purposes, a sale is a sale on the day a written agreement is entered into.

Hence, the date that a sale and purchase agreement is entered into for the sale of a property is usually the date of disposal for RPGT purposes. But what if there is no written agreement?

The law provides that the date of disposal is the earlier of two dates – the date that the sales price is fully received or the date that the ownership is transferred. Disposals of this nature may have disposal dates being deferred to a later date, which may fall in the 5% taxable period!

Likewise, disposal dates may be deferred even much later if the sale is dependent on securing approvals from the “Government or an authority, or committee appointed by the Government” – for example, the state government, the Securities Commission (SC) or Foreign Investment Committee.

For these “conditional contracts” which are covered by Para 16 of Schedule 2 of the RPGT Act, the disposal date is when the last of the approvals is obtained.

If a sale and purchase agreement is signed in December 2009 that is subject to SC approval which is obtained in February 2010, the disposal will be treated as having taken place in 2010 and thus subject to the 5% RPGT!

Stamp duty on the transfer

Stamp duty is imposed on the documents for the transfer of title; for example, the memorandum of transfer for transfer of property.

The rates applicable are fairly steep for properties which range from 1% to 3% with the highest rate of 3% being applicable for transfer prices which exceed RM500,000.

Transfers of shares attract duty at the rate of RM3 for every RM1,000 of the transfer price or 0.3%.

However, to avoid stamp duty, one may wish to transfer the property without the transfer of title; for example, the owner holds the property in trust for the company.

What if no transfer of title is effected as in these circumstances? Will the issue of tax avoidance then arise? Perhaps.

Anti-tax avoidance in the RPGT Act

Section 25 of the RPGT Act contains the general anti-avoidance provisions which allow the tax authorities to disregard transactions, vary transactions or impose taxes that should have been imposed.

The law specifies that this right is available if the transactions had the effect of “altering the incidence of tax”, “relieving a person from tax liability” or “evading or avoiding any liability which would otherwise have been imposed”.

Besides these general anti-tax avoidance measures which are also found in the Income Tax Act to discourage income tax avoidance, Section 25 of the RPGT Act also provides for persons who provide loans to related parties; for example, Mr A providing loans to Company A which is owned by him.

The law provides that if Company A sells a property and the property was financed by a loan provided by Mr A, the disposal may be regarded as a disposal by Mr A and not by Company A.

However, the cost of acquisition to Mr A is the market value of the property when Company A acquired the property from Mr A. If Company A had acquired the property from Mr A at the true market value, this anti-tax avoidance provision of the RPGT Act should not pose any problem.

Previous rules by Ministry of Finance (MOF)

A few years ago, the Government had granted a similar tax free period from June 1, 2003 to May 31, 2004.

During that period, the MOF had issued some guidelines to curb the avoidance of RPGT by mandating that any disposal of property must be evidenced by a sales and purchase agreement which must be duly signed and stamped within the exemption period.

Sale of property to a company in exchange for shares

Care should be taken if the property owner transfers a property to a company controlled by him in exchange for shares, or at least 75% in the form of shares. If the transfer is done this way, the shares may be considered to be chargeable assets.

In the future when these shares are sold, the gains will be subject to the RPGT of 5%. The cost of shares for RPGT purposes is not the par value of the shares but the price paid by the property owner for the property plus incidental expenses incurred by him on the acquisition; for example, legal fees.

As such, if Mr B transfers a piece of property acquired for RM1mil to his company (Company B) at market price of RM3mil in exchange for 3 million RM1 shares, and the shares are subsequently sold for RM4mil, the gains on disposal are calculated at RM3mil which is RM4mil sales price less the acquisition price to Mr B of RM1mil.

Indirectly therefore, Mr B is taxed on his full capital gains and not merely on the gains made by Company B owned by him.

RPGT or income tax?

Another aspect which has deep implications is whether the disposer had held the property as stock-in-trade or as a long term investment.

If held as stock-in-trade, the gains on disposal will attract income tax whereas if held as a long term investment, the gains will attract RPGT.

Some property investments which are disposed as part of a quick sale, or as a single isolated transaction in circumstances which give it a cloak of “adventure in the nature of trade”, could be caught under income tax.

Due to space constraints, we are unable to elaborate on this issue. If these disposals are caught under income tax, what then is the advantage of disposing the properties before Jan 1 if the disposer has to pay income tax at 25% on the gains upfront?

The obstacles can be quite challenging as seen above and careful navigation of the tax law is necessary. But I am sure good tax advisers will find a way out of the conundrum!

New lottery games, including toto, coming up

The introduction of new products by number forecast operators (NFOs) is intended to draw consumers away from illegal operators and expand the legal market.

Magnum Corp Sdn Bhd, a 51% subsidiary of Multi-Purpose Holdings Bhd, and Berjaya Sports Toto Bhd (BToto) were given the green light by the Government in the middle of this year to introduce new games – the first since the Government froze approvals in 1992.

In September, Magnum launched the 4D Jackpot while BToto is expected to release a new lotto variant, Power Toto 6/55, by year-end to replace its existing lotto games, Toto 6/42.

BToto’s new game was expected to have a much larger matrix of numbers for punters to select and a minimum guaranteed upfront jackpot of RM3mil, the highest minimum jackpot size currently, a research house said.

The approvals given to the two companies, coupled with the authorities’ generous allocation of special draws, had turned the operating environment in favour of legal NFOs, said a bank-backed brokerage in a report.

“It may not be overly optimistic to expect the legal market to grow beyond the low single-digit level with the latest expansion of product offerings,” it said.

It noted that the sector had high single-digit growth from 2003 to 2005, partly due to the extension of product offerings to the permutation variant.

Sales of NFOs had grown at a compounded average growth rate of 2.5% in the past 10 years, it said.

In an e-mail reply to StarBiz, the management of Magnum indicated that the sector remained resilient despite the difficult economic conditions.

“Sales have improved in the last few years albeit in the single-digit range and this is likely to sustain. Every business is not spared from the recession but it also depends on how severe the impact is.

“We believe everyone wants to nurture a little hope in his life and, for some lucky ones, this comes true with Magnum,” it said.

Another industry player, who declined to be named, said the NFO was a small-ticket item, hence the affordability for consumers even in a downturn.

The performance of NFO companies in the last 12 months was also an indication of the sector’s resilience.

“Whether upturn or downturn, punters will continue to punt,” he said.

Source: StarBiz

MNCs face greater transfer pricing scrutiny

Multinationals are facing new tax challenges due to growing transfer pricing (TP) scrutiny by world’s tax authorities, according to a survey.

The survey by international accounting firm Ernst & Young found a dramatic increase in the scope of TP documentation required by governments with penalties imposed more frequently and at higher levels when multinationals get it wrong.

Locally, Malaysia has introduced the new Sections 140A and 138C of the Income Tax Act 1967 relating to TP, which referred to the price charged by one part of an organisation for products and services it provides to another.

Given the need for governments to raise revenues in this challenging economic climate and the changing regulatory environment, the study anticipates heightened litigation in the near future.

This expectation was driven by the almost universal trend towards increased TP investigation resources within tax authorities, it said, adding that this trend was also shared by Malaysia.

“As governments search for tax revenues to offset growing budget deficits, many are sharpening their focus on compliance, enforcement and legislative approaches,” said Ernst & Young Malaysia partner and head of transfer pricing, Janice Wong.

“It has thus become inevitable that both domestic and multinational businesses be prepared for more TP audits and investigations,” she said.

In Malaysia, the Inland Revenue Board (IRB) has set up a dedicated Multinational Tax Department to focus its efforts and resources on TP matters such as TP audit, compliance, policy and advance pricing arrangement.

The specialist resources consist of accountants, economists and those with business and finance backgrounds, and the dedicated resources are expected to increase significantly.

Source: StarBiz

How to detect some early financial warnings in companies

TRADING volume on the stock market has recently been getting higher again. Some retail investors, who were absent from the recent rally, have started to get excited.

Over the past few months, investors were mainly focusing on good quality stocks, selling at a cheap level. However, attention has started to switch to poor quality stocks lately. Even though sometimes investors may be able to make money by betting on those stocks, we still need to be careful about the fundamentals of the companies. In this article, we will look at how to detect some early financial warnings.

A lot of companies like to make corporate announcements during the bull market. We agree that some of the announcements were genuine, but many corporate proposals were simply too good to be true.

If we analyse further, we will notice that the proposals might be way beyond the capabilities of the companies. Sometimes, the management’s projections of sales and profits were far beyond the past history. The capital expenditure requirements were well above the companies’ borrowing capacities.

Besides, the time required to turn the projects into profits might be too long. Nevertheless, as a result of the announcements, the stock prices would surge and normally, the main sellers behind might be the key owners.

We have also seen some proposals that turned out to be profitable. The companies did make profits in the first few years. However, the high growth in expansion stretched the capabilities of the top management, who might not have the experience and ability to run big businesses. They might have the experience to manage RM100mil turnover businesses. However, when the turnover surged beyond RM1bil per year, they might have problems. In fact, the main concerns to the companies were the top management team which lacked skills and experience to run big businesses.

We need to be careful if there are any changes to the key managers of the companies, auditors or accounting firms. The key managers are referred to the positions like chief executive officers and financial controllers. Besides, frequent changes in auditors provide serious financial warnings, especially the change from a reputable audit firm to an unknown one.

How to smell a rat or how to detect some early financial warnings in companies

Companies will soon start to report their financial results for the period ended Sept 30. In Malaysia, often good companies will try to announce their results before the deadline of Nov 30. However, if they are having difficulties in providing their financial statements, normally, we will expect some bad news to be announced. One of the possible explanations behind the delay is that the companies need more time to rectify certain financial problems.

Another potential sign of financial warning is when the companies venture into unrelated businesses. Previously, we saw many Bursa Malaysia second board companies going into financial distress in 1997/98 when they departed from their core businesses in manufacturing and ventured into property development activities.

We need to understand that when the company owners enter into areas that are not their core competencies, they might not be able to apply the knowledge and experiences accumulated previously. Instead, they would have to go through the entire learning curve again, which would result in the management taking a lot of time in managing those unrelated businesses.

In such situations, investors will need to pay attention and analyse whether those new ventures will be able to add value to the shareholders’ wealth. Some companies like to change their names after venturing into new businesses. Too frequent name changes may also imply that the companies have been shifting their core business focus and directions, which may not be good news to the shareholders.

Litigation is also another warning sign. We need to pay attention to companies that are involved in litigations, which may be either attributed to the companies being sued or they are suing someone else. These litigations may divert the management’s attention from day-to-day business operations. As a result, they may affect the companies’ performance as well.

One of the common questions asked by shareholders during any AGM is the directors’ fees. We need to analyse whether the fees paid are in proportion to the companies’ profitability. Sometimes, certain companies make excessive perks for owners as well as their employees or the lifestyle of the key owners is simply not consistent with the companies’ profitability.

The above are a few of the more common financial warnings that potential or existing shareholders must pay attention to when analysing the companies for investment. More importantly, we need to remain vigilant at all times and pay attention to the latest development of the companies.

Source: StarBiz

Maritime Laws in Malaysia

The following is a partial list of Malaysian maritime rules, regulations and laws:

. The Merchant Shipping Ordinance, 1952

. Boat Rules, 1953

. Contingency Plan for Straits of Malacca-Oil Spill Control

. Contingency Plan for Oil Spill Combat Team

. Environmental Quality Act 1974

. Exclusive Economic Zone Act 1984

. Federation Ports Rules, 1953

. Fisheries Act, 1985

. Light Dues Act 1953

. Merchant Shipping Act (Oil Pollution), 1994

. Merchant Shipping Examination for Certificate of Asean Oil Spill Response Action Plan (ASEAN OSPAR)

. Merchant Shipping Examination for Certificate of Competency (Deck) Rules 1998.

. Merchant Shipping Examination for Certificate of Competency (marine Engineer Officers) Rules 1998.

. Merchant Shipping Order (Collision Regulations), 1984

. Merchant Shipping Order (Collision Regulations) (Rules for Vessels Navigating Through Straits of Malacca and Straits of Singapore)

. National Contingency Plan - Oil Spill Control

. Petroleum Rules (Safety Measures)(Transportation of Petroleum by Sea), 1985

. Petroleum (Safety Measures) Act 1984

. Port (Safety of Workers) Rules, 1985

. State Ports Rules

Errant operators give direct selling business a bad name

SALES growth in the domestic direct selling industry has remained stagnant in recent years due to unscrupulous operators out to make a quick buck, says Malaysian Direct Distributors Association (MDDA) president Datin Sylvia Koh.

The sector saw sales of RM8 billion in 2006, but the numbers have been on the decline since. Sales were RM5.6 billion in 2007, and RM5.5 billion last year.

Koh blamed unscrupulous operators for tarnishing the image of registered direct sellers, attributing the drop in sales volume to negative perception among consumers about the direct selling business.

"They (unscrupulous operators) are giving us a bad name. Consumers are having negative perceptions due to this group's irresponsible activities," she told Business Times in an interview.

Koh was referring to a spate of scams such as the pyramid-type of business and get-rich-quick schemes that were purportedly linked to the direct selling industry.

"Consumers now are sceptical about direct selling companies. These irresponsible activities are actually mostly done by illegal and unregistered direct selling companies," she said.

Koh noted that out of the 100 complaints of cheating lodged with the Domestic Trade, Cooperatives and Consumerism Ministry, 90 were found to be committed by unregistered companies and 10 by registered companies, out of which only one is a member of the MDDA.

Currently, there are 670 direct selling companies registered with the ministry, although less than 20 per cent are members of the MDDA and its counterpart, the Direct Selling Association of Malaysia (DSAM).

"We have about 60 members, and DSAM has about the same figure. We hope to be able to attract more than 50 per cent of the registered companies to become our members or DSAM's," Koh said.

With this in mind, the MDDA will launch its homepage on Wednesday, which will be officiated by Domestic Trade, Cooperatives and Consumerism Minister Datuk Seri Ismail Sabri Yaakob.

"They (consumers) would be able to check whether the products and services offered to them are from the registered or legal direct selling companies as the website will provide a full list of MDDA members for them to counter-check," Koh added.

Koh expressed confidence that the direct selling industry in the country would prosper in future.

"Bear in mind that Malaysia is currently ranked 12th in terms of sales in the direct selling business worldwide. The potential here is huge," she said.

Source: Business Times

Global funds to focus corporate governance

GLOBAL investment funds are expected to pay more attention to corporate governance in Malaysia in line with their focus on investments in the country and the rest of Asia.

Secretary general of the Asian Corporate Governance Association, Jamie Allen, said the funds were expected to intensify their focus on Malaysia in the next few years.

"While Malaysia has made significant progress in terms of corporate governance, particularly in terms of better regulation, there are still areas that can be further improved," he said at a seminar on ''Governance Expectations of International Fund Managers'' organised by Bursa Malaysia in Kuala Lumpur today.

Allen said global investors looked forward to better information being given to make decisions during shareholders'' meetings.

"One of the problems is that investors do not get enough information, like the complete biodata of director."

"Another area that needs improvement is the voting system at companies'' meetings," he said.
He said voting by poll rather than through show of hands was better as it would promote efficiency and corporate governance.

Source: Business Times

Carriage of Goods by Sea

For a country with a significant sea-faring tradition and a substantial number of merchant fleets, Malaysia's maritime laws can appear to be anachronistic. The Malaysian Carriage of Goods by Sea Act ("MCOGSA") and Merchant Shipping Ordinance have hardly been reviewed since their respective enactments many decades ago. Moreover, by virtue of the Malaysian Civil Law Act, the English Bill of Lading Act (which dates back to the 19th century!) applies to Malaysia even though the United Kingdom has abandoned that statute in 1992.

Some pertinent issues involving international trade and, specifically, carriage of goods by sea, include:-

Bills of Lading ("B/L")

B/Ls are issued by the carrier/shipowner. They are usually signed by ship’s master.

B/Ls have 3 principal characteristics. First, it is evidence of receipt of goods by carrier.Second, it is a contract of carriage: s.4 MCOGSA. Third, it is prima facie document of title to goods (this is a defeasible title only because the buyer still has the right to reject goods under the Malaysian Sale of Goods Act ("SOGA").

A “Clean” B/L means goods received in perfect condition. A “Claused” B/L means goods may have defects as specified.

Bills of Lading Act (UK)

Repealed in UK (by the Carriage of Goods Act 1992 ("UKCOGSA") but still valid for Peninsular Malaysia under s.5(1) Civil Law Act. The Bill of Lading Act may not be applicable to the states of Sabah and Sarawak due to the operation of s.5(2) Civil Law Act.

The Bill of Lading Act is disadvantageous to the position of the buyer for the following reasons. First, the buyer has no privity of contract with carrier. Second, the buyer only assumes risk to goods. This enables the buyer can insure the goods but the buyer has no contractual standing to sue carrier. There is no privity of contract since the privity is between the vendor and the carrier. Third, the buyer can only sue after receiving the B/L. This is disdvantageous in the FOB delivery situation.

If the transport document is not a B/L e.g. a document called a Mate’s Receipt, the buyer cannot rely on the Bill of Lading Act for protection.

Comparison between the Hague, Hague-Visby & Hamburg Rules

Before 1924, the Common Law regime imposed ABSOLUTE liability for carriers, making carriers liable for the vessels' seaworthiness throughout the voyage. Unfortunately, during the deliberations to establish the Hague Rules, the merchant marine used their superior bargaining power to lobby for provisions that enabled carriers to contract out of common law liability. This was a set-back for international trade. This weakness was reflected in the Hague Rules (1924).

The Hague Rules were modified by amendments that became known as the Hague-Visby Rules which increased carrier's liability.

The most recent revamp was the Hamburg Rules that increased carriers' liabilities even further.

Readers should note that MCOGSA adopts Hague Rules while the UKCOGSA adopts Hague-Visby Rules. Countries like Singapore and Australia has adopted the Hamburg Rules.

Contracting out of liability of carriers – Hague (may be possible to contract out), Hague-Visby & Hamburg does not allow. In Hollandia Denning LJ said carriers cannot contract out of liability under H-V Rules.

• Duration of liability – Hague & Hague-Visby (only at time of commencement of voyage), Hamburg (throughout voyage – returns to common law position).
• Liability for deviation from route – Hague & Hague-Visby (no liability), Hamburg (liability).
• Liability of cargo-owner to inform about dangerous goods – Hague & Hague-Visby (no liability), Hamburg (cargo-owner liable for non-disclosure).
• Limitation period – Hague (1 year), Hague-Visby (1 year but can be extended by mutual agreement – must be clear, Hamburg (2 years).
• Liability of cargo-owner for freight & demurrage – Hague & Hague-Visby (cargo-owner liable even if B/L silent on this), Hamburg (cargo-owner not liable if B/L silent).
• Application to documents other than Bills of Lading – Hague (does not apply to non-bills of lading), Hague-Visby (can apply to any non-negotiable receipt but document must expressly say that H-V Rules apply), Hamburg (applies to any transport document for carriage of goods by sea).
• Particulars of goods in B/L – Hague (minimum requirements), Hague-Visby (more details than Hague), Hamburg (most number of particulars).
  

Observations

Malaysia’s reliance on the Hague Rules may be because it wants to protect the local merchant fleet. But if Malaysia aspires to be a modern maritime nation it must review the MCOGSA to adopt, at least, the Hague-Visby Rules. This will make Malaysian merchant fleet more attractive to foreign shippers/cargo-owners.

Since the Hamburg Rules protects the shippers/cargo-owners most countries with merchant fleet that adopt the Hamburg Rules may be the most attractive to shippers.

CIF 2: Cost, Insurance & Freight

This is a term used in the international sale of goods. CIF only specifies delivery terms and sets out the obligations of the seller and buyer respectively. CIF is, thus, only a part of the sale contract that pertains to delivery terms.

The norm is for the buyer and seller to rely on the International Commercial Terms also known as Incoterms prepared by the International Chamber of Commerce, ICC. Incoterms reflect current trade custom and practice and, it applies only to seaborne transportation of goods.

The CIF seller must arrange and bear cost of carriage of goods, marine insurance, customs clearance. All these costs will form part of cost of goods to the buyer.

Delivery of goods and delivery of title via shipping documents
CIF terms deal with the delivery of goods. But it also deals with the delivery of shipping documents. This was confirmed by the case authority of Kwei Tek Chao by the judge, Lord Devlin.

This is a good and practical mercantile law because it enables the buyer to re-sell goods upon receiving documents even before the physical goods arrive. And, the buyer can use shipping documents as security for banks to issue trade finance facilities such as the Letter of Credit to pay for the goods.

In the CIF-type situation, the buyer has 2 rights of rejection. First, the buyer can reject goods . Second, the buyer can reject documents.

Note that the right of rejection must be based on material non-conformity. If the non-conformity is too insignificant, the de minimis rule applies.

Most countries have laws that gives the buyer right to examine goods for conformity with description, or sample.

Note also that most countries have laws that imply a condition on quality, fitness and merchantability.

Shipping documents
Shipping documents referred to in the CIF clause includes the Bill of Lading, marine insurance certificate and invoice.
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The Bill of Lading has 3 important characteristics. First, it is a document of title – but title is defeasible until payment is received for the goods.

Second, the Bill of Lading is regarded as evidence of receipt of the goods by carrier. In most cases, the Letter of Credit will be paid based on the condition that the Bill of Lading must be clean which means that the goods were received in good condition by the carrier.

Third, the Bill of Lading is the contract of carriage. Since the Bill of Lading is issued to the seller, the issue tends to be whether buyer has privity of contract to sue carrier if goods damaged.

Passing of Risk
Both buyers and sellers should note that risk passes to the buyer when the goods cross the ship’s rail. This was decided in the case of The Pyrene by Lord Devlin.

Receipt of shipping documents by the buyer gives the buyer a defeasible right to property until payment made. Deafisible means a qualified right of ownership that is subject to the payment being fully made for the goods bought. But defeasible title is enough for buyer to secure trade finace facilities using the shipping documents with a bank for the Letter of Credit.

Sale of goods laws in most countries state that where goods shipped using Bills of Lading, the seller is deemed to reserve right of disposal and the title does not pass to the buyer until full payment is received by the seller.

Under the CIF arrangement, risk passes from the buyer to the seller only when title in the goods have passed. And, as explained above, under CIF arrangements final title or ownership passes only when the seller receives full payment.

CIF: Cost, Insurance & Freight

Cost, Insurance and Freight (CIF) is a common term in a sales contract that may be encountered in international trading when ocean transport is used. It must always indicate the port of destination, ie "CIF Shanghai."

When a price is quoted CIF, it means that the selling price includes the cost of the goods, the freight or transport costs and also the cost of marine insurance. CIF is an international commerce term (Incoterm).

CIF is identical in most particulars with Cost and Freight (CFR), and the same comments apply, including its applicability only to conventional maritime transport.

Risk of loss of, or damage to, the goods is for the buyer, just as with CFR. However, in addition to the CFR responsibilities, the seller under CIF must obtain in transferable form a marine insurance policy to cover the buyer's risks of transit with insurers of repute. The policy must cover the CIF price plus 10 per cent and where possible be in the currency of the contract.

Note that only very basic cover is required equivalent to the Institute "C" clauses, and buyers should normally insist on an "all-risk" type of policy such as that under the Institute "A" clauses.

The seller's responsibility for the goods ends when the goods have been delivered on board the shipping vessel. In the guidelines for CIF published in Incoterms 2000 the term "carrier" does not appear and it clearly states "the seller must deliver the goods on board the vessel at the port of shipment" which makes CIF the incorrect term to use where the seller wishes their responsibility to end when they deliver the goods into the hands of a carrier prior to the goods passing the ship's rail at the port of loading. In the great majority of transactions the more correct term is CIP.

This term is only appropriate for conventional maritime transport, not ro/ro or international container movements.

FOB 2: Free On Board

Exporters of bulk cargo such as palm oil, oil and gas in resource-rich countries like Malaysia will typically receive purchase orders with a Free On Board (FOB) delivery term. These bulk goods are loaded onto large ships known as bulk carriers or tankers. Bulk carriers and tanker fleets flying the M'sian flag include those owned by the MISC, Tanjung Offshore, Global Carriers and Bumi Armada.

The M'sian legal framework on delivery terms for carriage of goods by sea is rather archaic. There may be valid governmental policy reasons for this laggard posture, namely, the liability risk protection of vessels flying the M'sian flag. The time may have arrived for M'sian policy makers to start examining and balancing the need to protect M'sian-registered vessels against the goal of making M'sian maritime companies more competitive in the international arena.

Furthermore, there are significant risk issues involving the relative liabilities of the shipping carriers, the insurer, the exporters and the overseas importer. Many companies tend to leave these matters in the hands of the lower management, supervisory and clerical staff when quarterly revews are probably necessary. These are tactical management issues to be considered.

This issue is a large one and, I am narrowing the discourse into a series of blog entries. This entry focuses on the FOB delivery term.

FOB: Delivery term

FOB is a standardized goods delivery term commonly used in international trade. The International Chamber of Commerce has standardized the definition of FOB through Incoterms.

The salient features of FOB sales under Incoterms 2000 are that, firstly, the seller merely delivers the goods to the ship. Secondly, the buyer is obliged to nominate the ship, if buyer fails to do so can nominate substitute ship within a reasonable time. And, thirdly, the risk for loss of or damage to goods passes from seller to buyer when goods cross ship’s rail (The Pyrene) or when loaded on board ship which deems delivery of goods by seller to carrier to be good delivery to buyer. Generally, neither party is obliged to arrange insurance.

In deciding on the case of Kwei Tek Chao, Devlin J. noted that an unusual feature of Cost, Insurance and Freight (CIF) sales is that there are 2 parallel “transactions”. First, there is a physical delivery of goods where the goods must either conform to sample or description failing which buyer has right to reject goods after examination. Second, it involves the delivery of shipping documents where the documents must conform strictly to the description in the letter of credit failing which the buyer has the right to reject the documents for non-conformity.

In the case of Ganda Edible Oil the M’sian Federal Court noted that in FOB sales that involve documentary credit payments, these 2 rights of rejection are also available to the FOB buyer.

Delivery of goods
Physical delivery of goods by seller to the ship completes the seller’s obligations with respect to physical goods. Consistent with Devlin J.’s finding in The Pyrene and Incoterms on the FOB seller’s delivery obligations – delivery is completed when goods cross the ship’s rail and loaded on board the ship.
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Bills of lading (B/L)
In addition to delivery terms such as FOB, the contract for the carriage of goods is important. This carriage contract is evidenced by issuance of the B/L. The B/L has 3 characteristics as explained by Mustill LJ in The Delfini namely, the acknowledgement of receipt of goods by carrier, a document of title and, a contract of carriage of goods.

Under M’sian law B/Ls are governed by the English Bills of Lading Act 1855 (UKBLA) but the UK has moved since 1992 to a completely revamped Carriage of Goods by Sea Act to govern B/Ls and other carriage of goods contracts.

The UKBLA suffers from several disadvantages. Firstly, it recognizes only the B/L as the only form of carriage contract. Other carriage documents, for example, a mate’s receipt, are not protected by the UKBLA and, therefore, the endorsee can’t sue carrier.

Secondly, it links the right to property with right to sue, where right to property is transferred using different mechanism than B/L the endorsee may lose right to sue carrier. This is one of the judicial propositions from The Delfini.

Thirdly, it does not recognize the rights of part owners of unascertained bulk goods without benefit of transfer of property can’t sue carrier: eg Re Wait, Re London Wines. In such a case the “ascertainment by exhaustion” formula applied by Mustill J. in The Elafi is not available.

Delivery of documents
In FOB sales where documentary credit is used, as noted in Ganda Edible Oil, the right of the seller to demand payment arises when the shipping documents are delivered, even when goods are still at sea and, even when the goods have been lost at sea: Manbre Saccharine. The rationale may be that the buyer has recourse to insurance. But there must be actual delivery of goods on board a ship. If there were never any physical goods, seller has no right to claim payment: Hindley & Co v East India Produce.

Passing of risk
Although statutes on the sale of goods presumes that risk passes with property, which applies to “simple FOB” sales, for example FOB Incoterms that doesn’t involve documentary credit, under the “strict/classic FOB” and “FOB with additional services” the risk and property may pass at different times. However, in all FOB sales, risk passes when the goods cross the ship’s rail on The Pyrene principle. This gives the FOB buyer recourse to insurance for damage to or, loss of goods provided the FOB buyer takes up insurance coverage.

Passing of property
Legal scholars like Atiyah have noted that modern FOB sales are very similar to CIF sales in that documentary credit is widely used which requires the seller to retain title to goods. Thus retention of title by the FOB seller, as noted by Atiyah, is a function of securing payment by the buyer.

The general rule is that property passes in FOB sales when shipping documents are delivered and paid for by the buyer: The Aliakmon. Part payment is not good enough to transfer property in goods: Mitsui & Co v Flota Mercante. But since the seller arranges the carriage of goods, the B/L is issued in seller’s name, the seller has to indorse the B/L in favour of the buyer. This assumes that the goods are ascertainable.

First, where goods are unascertained, there must be an unconditional appropriation of the goods to enable property to pass from the seller to the buyer. Such issues often arise when the seller gets into financial or insolvency problems. One example is Carlos Federspiel where bicycles assembled and marked with buyer’s identification but remained at seller’s premises, the property couldn’t pass because FOB sales require goods to be delivered to ship. The appropriation was still conditional in that the seller could still change his mind. In contrast, in Hendy Lennox, the assembly of generators at seller’s premises in a Ex-Works sale with markings in favour of buyer was regarded as unconditional appropriation because all that was left was for buyer to arrange to collect the goods.

Second, the problem is made worse in bulk goods sales with several sub-buyers such as Re Wait and Re London Wines where part ownership of bulk goods are unappropriated & unascertained. Even if ascertained by the statutory sale of goods formulas, the sub-buyers can’t exercise independent rights of suit or obtain greater property rights. In UK the law reform in 1995 created a statutory formula to enable part owners of bulk goods to be given the statutory rights of “owners in common” of bulk goods. The legal anomaly still applies to M’sia.

Third, in international trade, sale of goods statutes operate to reserve title to property with seller. This was shown in the M’sian judicial decision in Shanti Kant where B/Ls made “to order” of timber logs could not pass to Indian buyer with a dubious claim. This allows the seller to ensure that payment is received before property in the goods is passed.

Fourth, in The Delfini, the buyer and seller had contractually agreed that property in the goods would pass upon delivery to the ship & that indemnities provided by the buyer would allow delivery of the goods. This is a situation similar to a “simple FOB” sale. Thus a sub-buyer on CIF terms could not claim against the carrier because it had no privity of contract in relation to the carrier. The B/L issued by the carrier was regarded by the English court of appeal, including Mustill LJ, as being a mere receipt for the goods. Since the goods had been delivered, the B/L could not be regarded as a document of title. In any case, property had passed to the buyer who could pass title to the sub-buyer independent of the B/L.

The Delfini was one of the cases that led to the repeal of the UKBLA in favour of the Carriage of Goods by Sea Act in 1992 that corrected the injustice in cases like The Delfini. M’sia remains under the UKBLA regime with all its defects.

Law reform proposition
There is a need for M’sia to consider adopting the statutory formula in the UK Sale of Goods Act and substitute UKBLA and Malaysian Carriage of Goods by Sea Act (which adopted The Hague Rules) with statutes for carriage of goods governing transport documents similar to the UK Carriage of Goods by Sea Act (which adopted The Hague-Visby Rules).

FOB: Free On Board

FOB is an abbreviation for Free On Board or Freight On Board. Generally, FOB deals with the shipping of goods. It specifies which party (buyer or seller) pays for which shipment and loading costs, and/or where responsibility for the goods is transferred. The last distinction is important for determining liability for goods lost or damaged in transit from the seller to the buyer. Precise meaning and usage of "FOB" can vary significantly. International shipments typically use "FOB" as defined by the Incoterm standards. Domestic shipments within the US or Canada often use a different meaning, specific to North America.

Under the Incoterm standard published by the International Chamber of Commerce, FOB stands for "Free On Board", and is always used in conjunction with a port of loading.Indicating "FOB port" means that the seller pays for transportation of the goods to the port of shipment, plus loading costs. The buyer pays cost of marine freight transport, insurance, unloading, and transportation from the arrival port to the final destination. The passing of risks occurs when the goods pass the ship's rail at the port of shipment.

For example, "FOB Vancouver" indicates that the seller will pay for transportation of the goods to the port of Vancouver, and the cost of loading the goods on to the cargo ship. The buyer pays for all costs beyond that point (including unloading). Responsibility for the goods is with the seller until the goods pass the ship's rail. Once loaded on to the ship, the buyer assumes risk.

Due to potential confusion with domestic North American usage of "FOB", it is recommended that the use of Incoterms be explicitly specified, along with the edition of the standard. For example, "FOB New York (Incoterms 2000)". Incoterms apply primarily to international trade, not domestic trade within a given country.

This use of "FOB" originated in the days of sailing ships. When the ICC first wrote their guidelines for use of the term in 1936, the ship's rail was often still relevant, as goods were often passed over the rail by hand. In the modern era of containerization, the term "ship's rail" is somewhat archaic for trade purposes. The standards have noted this.

Incoterms 1990 stated, "When the ship's rail serves no practical purpose, such as in the case of roll-on/roll-off or container traffic, the FCA term is more appropriate to use." Incoterms 2000 adopted the wording, "If the parties do not intend to deliver the goods across the ship's rail, the FCA term should be used.".