The hype is over! The long-debated goods and services tax ("GST") was implemented on 1 April 2015 by virtue of the Goods and Services Tax Act 2014 [Act 762] ("the GST Act"). Introduced as part of the government's tax reform programme to enhance the efficiency and efficacy of the taxation system, the rationale for GST is to eliminate inherent weaknesses in the now-abolished sales and service tax, which had a cascading effect due to what is known as "double taxation".1 That said, like many other sensational political issues in Malaysia, there are several differing schools of thought on its economic implications on a larger scale.
The key objective of this article is to provide an overview on the mechanics and dynamics of GST that a financier in Malaysia may face in connection with ship financing.
Inconsistency in definition of 'ship'
In accordance with s 2 of the Merchant Shipping Ordinance 1952 ("MSO"), the meaning of a "ship" includes every description of vessel used in navigation not propelled by oars. For the purposes of GST, however, the GST Act does not provide any definition as to what constitutes a "ship". In this regard, the Zero-Rated Supply Order 2014 comes to its rescue. Despite incorporating the interpretation of a "ship" as reflected in the MSO, the Zero-Rated Supply Order 2014 goes a step further to exclude vessels that are "designed or adapted for recreation, pleasure or other than freight or passenger transportation".2 The GST Guide on Shipping Industries, on the other hand, provides a list of vessels that do not constitute a "ship" for the purposes of GST. Among the excluded vessels are powerboats and yachts, although passenger liners are accepted as "ship". Why a distinction has been drawn between these vessels is unclear.
Notwithstanding the distinction drawn by the Zero-Rated Supply Order 2014 and the Guide on Shipping Industries, there is a string of established authorities that show pleasure crafts, motor boats and yachts come within the definition of "ship".3 One may argue that powerboats and yachts are expressly excluded from the definition for GST purposes due their private nature primarily designed for recreation or pleasure. We are unable to agree with this reasoning. It will be naïve to ignore the fact that powerboats or yachts can also be utilised to transport passengers in international waters for commercial purposes.
In this context, we took the liberty to consider the definition of "ship" under s 21(4)(a) of the Singapore Goods and Services Tax Act 1993. Prior to July 2010, a ship for the purposes of the Singapore GST Act was defined as one that is not designed or adapted for use for recreation or pleasure. Consequently, prescribed services did not enjoy zero rating. We can see the similarity between the Malaysian and Singapore GST Acts in this regard.
However, that definition was subsequently amended on 1 July 2010 to include ships used or adapted for recreation or pleasure, provided that they are wholly internationally bound.4 This means any services by ship used or adapted for recreation or pleasure that is used within international waters is now zero-rated in Singapore.
With respect, the haphazard distinction in regards to the definition of a "ship" provided in the Zero-Rated Supply Order 2014 and the Guide on Shipping Industries causes difficulty within the shipping industry. Our view is that the Zero-Rated Supply Order 2014 should be rectified to reflect established authorities. Alternatively, it will be worthwhile to explore the expansion of the definition of a "ship" as has been done in Singapore to maintain competitiveness within the shipping industry.
Overview of GST within shipping industry
A "ship" will fall within the ambit of movable property under the definition of "goods" provided by s 2 of the GST Act, following which any service within the shipping industry is subjected to GST at either the standard rate which is at 6%,5 or zero rate.6 The latter was introduced with the intention of boosting Malaysia's competitiveness abroad where GST registrants in such circumstances can claim input tax credit from the government for the production of taxable supplies.
To break it down into perspective, goods such as ship store supplies and spare parts purchased for the purposes of international voyages are zero-rated.7 These rates, however, do not extend to domestic travel. Similarly, services provided by intermediaries such as navigation and ship handling services,8 shipping agents or ship managers are zero-rated supplies.9 Further, services rendered by classification society, salvors and the supply of containers, whether by way of sale or leased, are also zero-rated. As most Malaysian shipping companies ply international routes, it can be surmised that most of their activities will be zero-rated10 as they involve exportation of services.
Effect of GST on facilities over vessel
It is settled that financial services specific to loan, advances or similar facilities are exempted from GST.11 This also extends to bonds, debentures or other similar financial instruments representing or evidencing debt, whether secured or otherwise.12
In short, apart from other considerations that may become payable for the usage of the facility, financiers shall not charge GST over the actual loan sum itself. "Other considerations" in this context will include fees relating to arranging, broking, advisory services, legal services and so on wherein the service provider shall charge GST at their respective GST rate.13 On a related note, it seems that supply of insurance coverage pertaining to the facility for the purchase of a vessel or the construction of a new ship is taxable supply at standard rate. However, based on item 14 of the Zero-Rated Supply Order 2014, if the insurance policy is meant to cover risks directly related to the export of a ship out of Malaysia, GST will then be zero-rated.14
Enforcement of mortgage over vessel
A mortgagee may wish to enforce his mortgage over a vessel when the shipowner is in default under the terms of the mortgage. The mortgagee has two possibilities in doing so. He may use "self-help" or seek the assistance of the court.
As for the first option, the mortgagee can exercise his right under the mortgage deed to take possession of the ship and appoint a receiver and manager to manage earnings from the vessel or, alternatively, to sell the ship.15 In practice, however, this may pose some difficulty since shipowners will not co-operate with the mortgagee who wishes to dispossess them of their vessel. Therefore, the mortgagee, more often than not, will choose to enforce his security through an in rem action and have the vessel arrested and subsequently sold by way of judicial sale to recover the debts under the facility.
Effect of GST on the sale of a ship
The sale of a ship is treated as a supply of goods. Accordingly, the supply of a ship, whether or not an onward trading of a whole ship or the construction of a new ship, is subject to GST at the standard rate.16 This also applies to the importation of foreign vessels into Malaysia to be registered under the Malaysian flag.17
However, the supply becomes zero-rated if the ship is built by a local business but eventually exported out of Malaysia. The key word here is "export". Therefore, if a vessel is built by a local business, then sold to a foreign registered company (and foreign flagged) but operates within Malaysian waters, the sale will not amount to "export of goods". In such instances, GST at standard rate will apply.
In a straightforward sale of a vessel, it is plain that the seller is liable to pay GST at standard rate but he is entitled, if the contract so allows, to require the purchaser to pay the GST. However, circumstances differ in the case of enforcement of mortgage. In this regard, we will have to consider sub-paragraph 5(7) of the First Schedule that ought to be read conjunctively with s 65(5) of the GST Act.
Sub-paragraph 5(7) of the First Schedule of the GST Act provides that:
Where any goods, forming part of the business assets of a taxable person, are sold by any other person who has the power to do so to recover any debt owed by the taxable person, the goods shall be deemed to be supplied by the taxable person in the course or furtherance of his business. (Emphasis added)
In this instance, it can be surmised that the borrower, in the event of default, will be deemed to be the person supplying the goods if the mortgagee chooses to enforce his right of sale over the vessel to recover the debt under the facility. However, this matter does not end here. In furtherance to the above sub-paragraph 5(7), one must also consider s 65(5) of the GST Act which provides as follows:
Where goods are deemed to be supplied by a taxable person pursuant to subparagraph 5(7) of the First Schedule, any person, whether or not he is a taxable person, who sells the goods in satisfaction of any debt owed by that taxable person, shall be liable for any tax due and payable on the supply. (Emphasis added)
This section addresses the question of "liability". In short, although the borrower is deemed as the "taxable person" in a mortgage scenario, according to s 65(5) of the GST Act, the party selling the vessel is the one ultimately accountable for GST arising out of the sale. In other words, the burden to account for GST shifts from the taxable person to the person carrying out the sale. Ordinarily, this consideration turns on the manner in which the sale is done, either through the enforcement of the mortgagee's debenture by a receiver and manager, or pursuant to a power of attorney or by virtue of a court order.
Sale of a ship by way of judicial sale
There are two main modes of judicial sale: sale by private treaty and sale by public auction. In normal circumstances, upon the execution of a warrant of arrest on the res (which is usually a ship), unless the owner of the res furnishes security for the claim, the res is likely to be subjected to judicial sale.18 In such case, the vessel will be sold by the sheriff free of all encumbrances by virtue of a court order.19 Once the vessel has successfully undergone the sale process, the proceeds of judicial sale will then be utilised to satisfy the plaintiff's claim and the claims of other parties, if any, according to an established order of priorities.
The authority to carry out a judicial sale is vested in the sheriff by virtue of a court order to sell the vessel. It is worth noting at this juncture that when the vessel is arrested, it enters into the care and custody of the sheriff, although possession of it is not thereby transferred.20 The question then is: Who is the actual vendor in a judicial sale of a vessel? This question plays a crucial role in determining who is in fact liable for GST in this regard.
There is no clear authority to suggest that the sheriff, in reality, carries out the judicial sale on behalf of the vendor in an enforcement of mortgage scenario, i.e. the mortgagee in this case. In light of this, we considered how the courts have interpreted the term "vendor" in a judicial sale in foreclosure proceedings, which is similar to the enforcement of mortgage deeds. The Malaysian courts have on several occasions held that the "chargee" must be regarded as the vendor in judicial sale for foreclosure proceedings.21 If the same rationale applies, regardless whether the judicial sale of a ship is by way of public auction or private treaty, although the sale of the vessel takes place in the name of the sheriff, the mortgagee of the ship remains the actual vendor in the judicial sale.
This proposition is consistent with the GST Act. The term "any person who sells" in sub-paragraph 5(7) ought to reflect the person who has the "power to recover any debt" as provided in s 65 of the GST Act. Reference to the word "power" in this instance certainly must be the mortgagee. Therefore, we take the view that the obligation to pay GST ultimately lies with the mortgagee in a judicial sale of a vessel.
(i) By way of private treaty sale
Principally, the implication of GST in judicial sale — or rather known as a "court sale" — is no different from an ordinary private tender exercise, i.e. GST at standard rate is applicable. As for potential bidders who place a deposit to register their interest in the tender exercise, there is no obligation to pay GST on the receipt of the "deposit" until the said deposit forms part of the full payment made by the successful bidder towards the purchase of the vessel. Accordingly, if their bid becomes unsuccessful, their deposit will be returned without any additional charges.
One may also wish to take note that although court-related services are exempted supply,22 GST at standard rate is still chargeable for the additional services rendered towards the sale. For instance, this may include advertisement of the sale and/or expenses incurred by the sheriff during the arrest period.23 In order to ensure GST is claimable at the conclusion of the sale from the purchaser, solicitors acting for the mortgagee (who usually assists the sheriff in the preparation of the proclamation of sale) must be minded to specifically include conditions with respect to the payment of GST in addition to the contract price, example of which is set out below.
(ii) By way of auction process
In our opinion, the blanket statement that an auctioneer only acts as an agent for the owner or financier as provided in the GST Guide on Auctioneer24 is inaccurate. More often than not, an auctioneer is called to assist the sheriff, the receiver and manager or persons executing the power of attorney to sell a ship by way of public auction. The auctioneer is engaged to merely carry out the auction exercises while the mortgagee remains the selling party. Therefore, the auctioneer's liability is limited to his duty to account for GST in so far as it concerns the services rendered by him to assist the court as an auctioneer. He will not be liable to pay for GST on the sale of the vessel, which will be the duty of the mortgagee instead as discussed earlier. It is nonetheless imperative that before the vessel is auctioned, the auctioneer must first inform bidders that the vessel is subject to the payment of GST.
We know that the essence of GST is based on a value-added concept. From our understanding, the solution to s 65(5) of the GST Act is relatively simple. The person selling the vessel must ensure that the conditions of sale, whether in the form of a contract for sale or proclamation of sale, provide for the payment of GST in addition to the contract price.
A sample GST term would read as follows:
Goods and Services Tax (GST)
- Unless specified to the contrary in the Contract Details, all prices are exclusive of Goods and Services Tax ("GST") on the Services and Products and other supplies made under this Contract to the extent that they are taxable supplies within the meaning of the Goods and Services Tax Act 2014 ('the GST Act').
- In this clause, a word or expression defined in the GST Act has the meaning given to it in that Act.
- If a party (Supplier) makes a supply under or in connection with this Contract in respect of which GST is payable, the recipient of the supply (Recipient) must pay to the Supplier, an additional amount equal to the GST payable on the supply (GST Amount).
In summary, the terms in the agreement leading to the sale and purchase of a vessel and/or proclamation of sale must specifically spell out that GST charges ought to be borne by the purchaser, in addition to the purchase price. Otherwise, the mortgagee could be held accountable for those charges. Whether this is a fair burden placed on the mortgagee, who is merely enforcing his rights under the facility, warrants an article by itself.
It is undeniable that the GST will affect all individuals and industries. However, the extent of its impact varies, depending on the type of activity. Compared to other industries, the GST is likely to have minimal impact on the merchant shipping sector and maritime supply chain as most international trade activities are zero-rated. The rationale for this is to maintain competitiveness of the seaborne trade in Malaysia.25
Apart from the million-dollar question as to whether Malaysia is in fact ready for the GST, the implication of GST should not be taken lightly as it has a proven track record in countries that have implemented it thus far. With proper understanding of and education on the impact of GST, it may well be a way forward in tackling the nation's fiscal deficit.
2 Section 17 of the GST Act, read with item 2 of the Goods and Services Tax (Zero-Rated Supply) Order 2014 (PU(A) 272/2014)
3 For example, in The Winnie Rig (1998) 2 Lloyd's Rep 675, a motor yacht was held to be a ship
4 Item 6 of the Singapore Goods and Services Tax (Amendment) Act 2010
5 Goods and Services Tax (Rate of Tax) Order 2014 (PU(A) 184/2014)
6 Royal Malaysian Customs Department, Goods and Services Tax (Guide on Shipping Industry), 24 March 2014
7 First Schedule of Goods and Services Tax (Zero-Rated Supply) Order 2014 (PU(A) 272/2014)
8 For example, pilotage, towage, berthing, wharfage and so on
9 Supra, n 7
10 Paragraph 3 of the Second Schedule of the Goods and Services Tax (Zero-Rated Supply) Order 2014 (PU(A) 272/2014)
11 Section 18(2) of the GST Act 2014, read with item 2 of Second Schedule of the Federal Government Gazette Goods and Services Tax (Exempt Supply) Order 2014 (PU(A) 271/2014). See also Royal Malaysian Customs Department, Goods and Services Tax (Guide on Commercial Banking), 19 November 2013
12 Ibid, item 7 of the Second Schedule of the Exempt Supply Order 2014
13 Ibid, item 12 of the Second Schedule of the Exempt Supply Order 2014
14 Ibid, item 14(a) of the Second Schedule of the Exempt Supply Order 2014
15 Goldrein, Ian S, Ship Sale and Purchase (2nd Ed, Lloyd's of London Press Ltd (1993) at 211
16 Supra, n 2
17 Sections 9 and 13 of the GST Act
18 Order 29 of the Rules of Court 2012
19 A "ship", in this instance, includes her apparel, tackle and stores on board the ship
20 Kian Sing, Toh, Admiralty Law and Practice (2nd Ed, LexisNexis (2007) at 180
21 Kimlin Housing Development Sdn Bhd (Appointed Receiver & Manager) (In Liquidation) v Bank Bumiputra (M) Bhd  2 MLJ 805 (SC); Public Bank Bhd v Phan Seng Kee  3 CLJ Rep 491; M & J Frozen Food Sdn Bhd v Siland Sdn Bhd  1 MLJ 294 (SC)
22 Section 64 of the GST Act 2014
23 Section 65(5) read with sub-paragraph 5(7) of the First Schedule of the GST Act 2014
24 By the Royal Malaysian Customs Department, 18 July 2013
25 Margaret Ang Guat Hee and Laksme Khorana, "An Assessment of the Introduction of Goods and Services Tax (GST) in Malaysia and its Implications on the Merchant Shipping Sector and Maritime Supply Chain". See (http://www.mima.gov.my/mima/wp-content/uploads/gst%20-%20final%20report%2020jul10.pdf)
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.