Introduction to the legal and regulatory canvas of the Malaysian Petroleum Industry

Overview

Malaysia is the 11th largest oil producing country in the world and the 2nd largest at this in South East Asia. Malaysia is blessed with its strategic location that enables it to grow its oil production industry due to it being spread across the South China Sea from the state of Kelantan in West Malaysia to the state of Sabah in East Malaysia which are within the Northern spread of the South China Sea and from the states of Johor to Sarawak at the southern end of the spread.

This area encompasses a very large production field which enables Malaysia to comfortably sit among the big producers globally as well as regionally. The oil and gas industry makes up of almost a fifth of the country’s gross domestic production and, according to MIDA, had projects worth more than RM350 million approved in the year 2020.

Malaysia has held almost 3 billion barrels of oil in reserves since 2015 due to increase in production.

The production of petroleum in Malaysia is managed by the statutorily formed company known as Petronas (short for Petroliam Nasional Berhad) which was formed in 1975. This company has the complete ownership and rights to grant and manage the exploration and production of petroleum in Malaysia ever since. Before 1975, the petrol concessions were granted by state governments.

Petronas’s through the power vested upon it by the Petroleum Development Act 1975 (“PDA 75”) and in tandem with the Petroleum Regulations 1974 (“PR 74”)is the responsible authority for granting licenses to third parties wishing to take part in upstream petroleum exploration.

The duties and powers conferred by the PDA 75 to Petronas is executed by the Malaysian Petroleum Management (MPM) division within Petronas. This division will usually act as regulators of third party exploration contractors while carrying out their own exploration projects.

The exploration and production arm of Petronas is known as Petronas Carigali Sdn Bhd (Carigali). This arm is wholly owned by Petronas and is always included as a party to any Product Sharing Contract (PSC) entered into by Petronas. The PSC provides the exploration rights to third party exploration companies. Any oil and gas discovered pursuant to the PSC, the third party exploration company can develop and produce the oil and gas resources.

Petronas also has something known as a Risk Service Contract (RSC). This is to bind third party company keen to develop oil and gas from marginal fields. Usually in RSC, the contractors bear the cost of operations while Petronas retain ownership of the oil. When there is discovery of a commercial field, the cost of operations to discover will be reimbursed to the contractors. The RSC contractors are entitled to a share of the profit.

General Acts of Law and Regulations used to regulate the Petroleum Industry

The key laws and regulations in relation to oil and activities in Malaysia are:

1. the Companies Act 1965, which sets out the legal basis upon which companies are formed, operated and managed;
2. the Continental Shelf Act 1966 (“CSA”) extend Petronas’ exclusive rights to petroleum to include Malaysia’s exclusive economic zone and its continental shelf respectively;
3. the PDA, which provides for the vesting of the entire ownership of, as well as rights, privileges and benefits in relation to exploring and producing oil and gas, offshore and onshore Malaysia, in Petronas;
4. the Petroleum Regulations, which sets out the licensing requirements for upstream and downstream activities of refining, marketing and distribution of oil products;
5. in addition to exclusive rights over petroleum onshore and within the territorial seas of Malaysia, the Exclusive Economic Zone Act 1984 (“EEZA”);
6. the Petroleum (Safety Measures) Act 1984 (“PSMA”) and its associated regulations which govern petroleum transportation, storage and handling;
7. Petronas licensing guidelines, which sets out the general requirements for application of Petronas licences or registration and the local bumiputra participation requirement for equity, board of directors, management and employees based on the SWEC applied by Petronas. Petronas has imposed local incorporation and equity requirements for certain activities in the petroleum sector, pursuant to its powers and responsibilities under the PDA and Petroleum Regulations, and accordingly corporations wishing to engage in such activities must comply with such requirements in order to obtain the necessary licences from Petronas for their business operations in Malaysia;
8. the Environmental Quality Act 1974 (“EQA”), the primary legislation governing the protection of the environment and the prevention of oil spills and pollutants on land and in Malaysian waters; and (h) the Merchant Shipping Ordinance 1952 (“MSO”), the primary legislation governing licensing of vessels in Malaysia. All vessels engaged in providing shipping services in the Malaysian domestic shipping sector must be licensed by the Domestic Shipping Licensing Board under the Ministry of Transport.

Key Regulatory Bodies

Under the PDA, all upstream activities such as exploration, development and production of resources are regulated by Petronas through PSCs and RSCs that contractors are required to enter into with Petronas in order to acquire the right to explore and produce oil in Malaysia. Goods and service providers operating in the upstream sector including providers of rigs and drilling services and supply of general goods and services related to upstream operations also require a licence from Petronas.

Under the Petroleum Regulations, the Ministry of International Trade and Industry (“MITI”) is responsible for regulating the processing or refining of petroleum or manufacture of petrochemical products from petroleum, and the Ministry of Domestic Trade and Consumer Affairs (“MDTCA”) is responsible for regulating the marketing and distribution of petroleum and petrochemical products in Malaysia

Policies with regards to Oil and Gas Activities

There are various policies which are in place with regards to Oil and Gas activities in Malaysia. The policies were put in place to streamline industry practices and to ensure sustainable long standing supply of oil and gas in Malaysia.

The first such policy was introduced in 1975. It was called the National Petroleum Policy. This policy was introduced to ensure that Malaysia plays a big part in managing and operating within the petroleum industry. Apart from this the policy also strives for proper and efficacious use of the petroleum resources in Malaysia.

Shortly thereafter, in 1979 the National Energy Policy was introduced. This policy was introduced to put in place broad guidelines on energy related objectives and strategic framework for adequate and cost effective supply of energy, ensure effective use of energy and to reduce the adverse effect of energy generation towards the environment. In the duration of the next year the National Depletion Policy was introduced to preserve the levels of national oil and gas stockpile.

In 1981, the Four Fuel Diversification Policy was established to promote reliability and security of the energy supply via a variety of energy resources. This was done to enhance the sustainability of energy in the country for the long term. This policy was further enhanced in 2001 by the Fifth Fuel Policy.

In 2001 the Energy commission was formed pursuant to the Energy Commission Act 2001. The said commission was authorized to enforce and regulate all matters relating to energy supply activities and laws in the country.

Further down the timeline, in 2006, the National Biofuel Policy. This policy focuses on the commercialization, usage, research, technology and export of biodiesel but does not include upstream aspects of sector development.

The Malaysian Government also placed a lot of emphasis on the use of renewable energy source and energy efficiency through the 11th Malaysian Plan from 2016 until 2020)

Moving on to the future, the Malaysian government has put in place via the 12th Malaysia Plan, economic freedom to grow sustainable resources of energy. This will be fleshed out by the introductions of various policies, legal frameworks and regulations.

With these policies in place, the future of oil and gas in various forms looks to be in good hands as the main stakeholders including Petronas and other government arms driving the initiative forward.

Regulatory issues pertaining to Downstream and Upstream Sectors

Downstream Regulatory Issues

Transportation

Relevant Laws and Regulatory Bodies

The PSMA and its associated regulations govern the transportation, storage and handling of petroleum. The PSMA regulates all modes of transportation of petroleum, including transportation of petroleum by road and railway, by water, and by pipelines.

The transportation of petroleum in pipelines to places, including production facilities, tank farms, natural gas processing plants and terminals (covered pipelines), are governed by the PSMA and the Petroleum (Safety Measures) (Transportation of Petroleum by Pipelines) Regulations 1985 (“PSMR-Pipelines”), save for certain pipelines which are excluded from the application of the PSMA, such as pipelines within refineries, industrial plant, bulk plants and service stations.

Under the PSMR-Pipelines, separate authorisations are required for the installation and operation of pipelines. A contractor must submit an application to the Department of Occupational Safety and Health (“DOSH”), which is entrusted by the MDTCA (the original ministry responsible for issuing the licence), in order to obtain the relevant licences.

The requirements for vessels carrying petroleum are provided under the Petroleum (Safety Measures) (Transportation of Petroleum by Water) Regulations 1985 (“PSMR-Water”).

The PSMR-Water provides for, amongst others, the requirement for all vessels carrying prescribed classes of petroleum to be licensed by the Surveyor General of Ships. The Marine Department of the Ministry of Transport is the main government department which administers matters relating to the shipping industry in Malaysia, which include regulating the registration of Malaysian ships and providing for a Malaysian international registry.

The Merchant Shipping Ordinance 1952 (“MSO”) provides that domestic shipping must be conducted by Malaysian registered ships. The Domestic Shipping Licensing Board regulates and controls the licensing of ships which conducts domestic shipping between any ports in Malaysia.

In respect of transportation by land, the Land Public Transport Commission enforces the Land Public Transport Act in regulating all land-based public transport. The Land Public Transport Commission is responsible for issuing commercial vehicle licenses to prime-movers which transport petroleum products.

Upstream Regulatory Issues

Upstream Exploration and Production General Character of Oil Exploration and Production Activity All exploration and production are dependent upon approval by Petronas, and Petronas determines the exploration locations and blocks. Presently, all oil exploration and oil production activities in Malaysia are conducted offshore.

Ownership of Title over Oil Reservoirs Pursuant to the PDA, Petronas is vested with the entire ownership in, and the exclusive rights, powers, liberties and privileges of exploring, exploiting, winning and obtaining oil and gas whether onshore or offshore of Malaysia, which extends to include Malaysia’s exclusive economic zone and its continental shelf. In relation to oil and gas, there is no legal distinction between surface rights and subsurface mineral rights.

Given that the ownership of the petroleum vests in Petronas, any transfer or disposal of title in the extracted oil would be subjected to Petronas’ consent or approval. As such, the terms of the transfer of title is generally set out in the contract between the licensee, lessee or contractor and Petronas.

Seaward Extent subject to Regulatory Regime for Oil Production Under the EEZA, Malaysia’s exclusive economic zone extends to 200 nautical miles from the baselines from which the breadth of its territorial seas is measured. Malaysia has sovereign rights for the purpose of exploring and exploiting natural resources in its exclusive economic zone.

Procedures and Licensing Requirements for Grant of Exploration and Production Rights

A contractor wishing to participate in oil exploration and production activities must apply for and receive a licence from Petronas. Although the PDA and Petroleum Regulations are silent on what form such licence should take, in practice, the licence will normally take the form of a PSC or RSC.

The Petroleum Regulations provide that the applications for a licence shall be made to the President of Petronas and thereafter the Chairman and Chief Executive of Petronas shall process the applications and forward such applications to the Prime Minister for approval.

Other than the aforementioned, neither the PDA nor the Petroleum Regulations stipulate the procedures and/or selection criteria for a contractor to qualify to apply for a PSC with Petronas. For the purposes of the licence application, the Petronas Guidelines provide that the interested entity must be registered with the Registrar of Companies as a private limited company; a public company or land surveyor, quantity surveyor, architect or other related professional bodies.

It should be noted that under the new Companies Act 2016, companies may be formed by a single person and the prohibition on carrying on business with less than two shareholders no longer applies.

Under the Petronas Guidelines, the company is also required to, amongst other things, have a minimum paid up capital of RM 100,000 for a licence application and meet the applicable bumiputra participation requirement in accordance with the SWEC.

The successful contractor explores for hydrocarbons on behalf of Petronas, and if oil or gas is discovered during the duration of the PSC or RSC, it can subsequently proceed to develop and produce the hydrocarbons resources. The rights to oil exploration and production can be secured through participating in the Petronas bidding rounds for a PSC or RSC.

Alternatively, farm-ins into existing contracts can be undertaken with the prior approval of Petronas. In Malaysia, there is no separate legal regime for joint ventures in the oil sector. Contracting parties to a PSC can be one or more companies but there must always be at least one company that ‘operates’ on behalf of all contracting parties.

The PSC requires the contractors to enter into a joint operating agreement (“JOA”) in instances whereby there is more than one contractor to the PSC. The contractual relationship, rights and liabilities are regulated through the JOA. Each party’s participating interests and obligations in the joint venture are set out in the JOA.

Limitations on Foreign Companies Acquisition of Oil-related Interests

For upstream exploration and production activities, there are no special requirements or limitations at law on the participation of foreign companies. In order to participate in exploration and production activities, foreign companies must receive a licence from Petronas, which in practice, will normally take the form of a PSC.

There are substantial local or bumiputera equity conditions for companies wishing to supply goods and services, i.e., which are enforced through the Petronas licensing regime. As such, foreign companies in the business of supplying goods and services to the upstream oil industry in Malaysia often either do so through an agency agreement with local companies licensed by Petronas, or by forming a joint venture with a local company / individual.

Petronas’s Participation and Co-operation in PSCs

It is the policy of Petronas that Petronas’s wholly owned subsidiary, Carigali, its exploration and production arm, is one of the contracting parties to each PSC. Carigali’s participating interest in each PSC varies, but it usually participates with no less than 15% interest.

Additionally, it is not unusual for there to be more than one contracting party to the PSC owing to the high-risk nature of the venture, including the risk that no commercially viable hydrocarbons may be found despite considerable capital outlay. However, there will usually be one designated “Operator” with primary responsibility who “operates” on behalf of all other participating contractors.

Carigali may also be the operator, but this is not generally the case. The term of a PSC or RSC will vary. There will generally be timeframes for exploration, development and production. The period for production for PSCs is typically 20 years and thereafter, may be extended from time to time upon an application for extension.

Oil Royalties

The PDA provides that royalties (or ‘cash payment’, as provided under the PDA) are payable by Petronas to the federal government and each of the thirteen state governments to the extent petroleum production is undertaken in or offshore from the relevant state’s shore. The royalty rates are set out in agreements between Petronas and the federal government and each of the 13 state governments.

These agreements currently provide for 5 per cent of the value of the petroleum obtained to be paid to the state in which the oil is found, and 5 per cent to be paid to the federal government. Instead of royalties, the PSC or RSC contractors will have to pay export duty for the export of crude oil.

Title to Facilities and Equipment used for Oil Exploration, Development and Transport

The title to all equipment and assets purchased by PSC contractors which are used for oil exploration and petroleum operations are generally vested with Petronas. The contractors retain the right to use those assets for the duration of the relevant PSC. The costs of such items are recoverable in barrels of cost oil or gas equivalent.

No Difference between Exploration and Production Activities Onshore and Offshore

The PDA regulates the exploration and production of petroleum, which is defined under the act as ‘any mineral oil or relative hydrocarbon and natural gas existing in its natural condition and casinghead petroleum spirit including bituminous shales and other stratified deposits from which oil can be extracted’. As such, there is no difference between the onshore and offshore regimes as both are governed by the PDA.

Reservoir Unitisation applicable to Domestic and CrossBorder Reservoirs

It is a standard provision in the PSCs, that Petronas may ask the affected PSC contractors to unitise the reservoirs, where Petronas is satisfied that the strata in a PSC contract area forms a single geological structure or reservoir with another PSC contract area. In respect of cross-border reservoirs, Petronas will, upon consulting with contractors of the relevant PSC areas, represent PSC contract areas in the international unitisation agreements. PSC contractors are required to comply with the terms agreed by Petronas in international unitisation agreements.

Contractual Limitation of Liability

The limitation of liabilities of each party is set out in the JOA, PSC or RSC. The contractors are required under the PSC to provide all the financing and bear all the risk of exploration, development and production activities in exchange for a share of the total production. The PSC contractors are also required to, amongst others, seek authorisation prior to incurring any expenditure beyond a certain threshold, and other approvals from Petronas throughout all stages of operations.

Failure to comply with these requirements may result in a termination of their rights to carry out the operations. Further, the Petroleum Regulations provide that any person who, amongst others, fails to comply with any condition of the Petronas licence shall be guilty of an offence and on conviction, shall be liable to a fine not exceeding RM 50,000 or to imprisonment for a term not exceeding two years, or both and in the case of a continuing offence he or she shall be liable to a further fine of RM 1,000 for each day or part of a day during which the offence continues after the first day in respect of which the conviction is recorded.

Parental Guarantees or Other Forms of Economic Support

Parental guarantees would be required where a subsidiary is a party to the PSC or RSC. Such parental guarantees need not necessarily be from an ultimate parent but would have to cover all commitments of the subsidiary. Bank guarantees and security deposits are not normally used to cover all commitments. They may be required for specific work commitments or to cover certain operations.

Consent for Transfers to Third Parties

According to the MDTCA Guidelines on PDA, a PDA licence may not be transferred unless permission is granted by Petronas. PSCs or RSCs will typically impose the requirement on a contractor to obtain Petronas’ prior approval before any participating interests in the PSCs or RSCs of the contractor may be transferred or assigned to any related party and will also stipulate that the consent of other contractors is also required for an assignment or transfer of a participating interest to a third party (other than a related party), though such consent shall not be unreasonably withheld.

If the operator is a Petronas licence holder, a change of shareholding or control of the operator will also require the consent of Petronas under the relevant PSC or RSC. There is no law or regulation that expressly provides for the procedures for obtaining approval for change of control.

However, the PSC or RSC will typically contain a change in control clause, which requires a contractor to obtain written consent of Petronas before affecting a change in control of the contractor. The approximate timeline for obtaining approval from Petronas is six weeks to two months. There are also no legislative provisions or guidelines providing pre-emptive rights. Any such rights will be contractual. Whilst there are no specific fees or taxes levied by the government on a transfer or change of control, stamp duty would be payable on the instrument effecting the transfer or change in control.

Cost Recovery

The PSCs entered into between contractors and Petronas set out the provisions which govern the payment of royalty, caps on cost oil, and sharing in profits from the production of petroleum. Cost oil is the share of production that is allocated to contractors to permit the contractors to recover the costs it has incurred in conducting operations under the PSC.

Notably, the cost recovery does have a ‘ceiling’ as sanctioned by Petronas which is up to 50% since 1976 PSC and revised to 70% in later version of contracts. A PSC may stipulate terms that reduce entitlement of production for respective PSC contractors once the PSC contractors reach certain cost-recovery milestones laid down in the PSC.

In accordance with the Petronas Procedures and Guidelines for Upstream Activities (“PPGUA”), which are required to be complied with by parties to PSCs with Petronas in Malaysia, there are generally, three categories of non-recoverable costs (“NR costs”), which are:

1. governance and common issues;
2. pending approval from Petronas; and
3. operational and business risks.

The NR costs are usually detailed in the terms of the PSCs.

Decommissioning

Legal Framework and Operation

Whilst there is no specific decommissioning regulations in Malaysia, there are provisions of several legislations which would be applicable to the abandonment and decommissioning of oil and gas facilities and pipelines in Malaysia, such as:

1. the EQA, which prohibits discharge of oil and wastes into the Malaysian waters;
2. the CSA, which empowers the Yang di-Pertuan Agong to make regulations for, amongst others, the removal of installations or devices constructed, erected, or placed in, on, or above the continental shelf which have been abandoned or become disused34;
3. the Occupational Safety and Health Act 1994 (“OSHA”), which generally covers the safety, health and welfare of persons at work and protection of others against risks to safety and health in connection with the activities of persons at work;
4. the MSO, which empowers the Minister of Transport to make regulations to ensure the safety of and control over offshore industry structures, offshore industry mobile units and vessels35; and
5. the EEZA, which requires the owner of any submarine cable or pipeline which has fallen into disuse or is beyond repair to inform the Government and to remove such cable or pipeline where it is directed to do so by the Government.

The legislation requires relevant operators in the oil and gas industry to ensure that the abandonment and decommissioning activities are carried out in a safe manner. Further, such activities must not cause any pollution or interfere with other offshore activities. Petronas also regulates the decommissioning of oil and gas structures through PSCs and RSCs.

The Guidelines for Decommissioning of Upstream Installations as part of the PPGUA, provides the regulatory framework for decommissioning of facilities. Malaysia is also a party to various international conventions that regulate the decommissioning of offshore installations, such as the London Dumping Convention 1972/1996, the Geneva Convention on Continental Shelf 1958 and the United Nations Convention on the Law of the Sea 1982.

The Malaysian PSC typically requires a contribution of abandonment cess to Petronas. The operator is responsible for calculating the cess payments annually in respect of its abandonment work programme and budget and to submit such calculations to Petronas for approval. Such calculation of the annual abandonment cess is by reference to the annual production in million barrels of oil equivalent and an estimated abandonment cost. However, the operator is entitled to recover these costs through the cost recovery mechanism in the PSC from Petronas.

Health, Safety and Environment (“HSE”) Laws and Regulatory Requirements

HSE Requirements to Oil-related Facility Operations

The EQA is the legislation that governs environmental matters in Malaysia. The Department of Environment was established under the EQA in order to regulate all controls relating to industrial pollution and promote environmental protection.

Generally, the EQA and its accompanying regulations require an environmental impact assessment (“EIA”), project siting evaluation, pollution control assessment, monitoring and self-enforcement to be conducted in relation to prescribed industrial projects. Prior to the implementation of prescribed industrial projects or activities, relevant companies must obtain, amongst others, the following approvals from the director general of Environment Quality:

1. an EIA for prescribed activities;
2. site suitability evaluation (for non-prescribed activities);
3. written notification or permission to construct;
4. written approval for installation of incinerator, fuel burning equipment and chimney; and
5. a licence to occupy and operate prescribed premises and prescribed conveyances.

Under the Environmental Quality (Prescribed Activities) (Environment Impact Assessment) Order 2015, the development and construction of petroleum related facilities are listed as prescribed activities.

An EIA must be carried out and submitted to the Director General of Environmental Quality for approval, if the project includes any of the following activities:

1. the development of an oilfield, gas field or oil and gas field;
2. construction of offshore or onshore pipelines in excess of 30 kilometres in length;
3. construction of oil or gas separation, processing, handling and storage facilities; and
4. construction of product depot for the storage of petrol, gas or diesel that has the combined storage capacity of 60,000 barrels or more (excluding service station) within three kilometres of any commercial, industrial or residential area.

Under the EQA, any person who carries out a prescribed activity without submitting an EIA report will be committing an offence and shall be liable to a fine not exceeding RM 500,000 or to imprisonment for a period not exceeding five years or to both and to a further fine of RM 1,000 for every day that the offence is continued after receiving a notice from the director general requiring him or her to comply with the act specified in the notice.

In addition, the EQA expressly prohibits any unlicensed person from discharging or spilling any oil or mixture containing oil into Malaysian waters in contravention of the acceptable conditions specified under the EQA for the emission, discharge or deposit of oil or any mixture containing oil.

Any person who breaches the above sections will be guilty of an offence and shall be liable to a fine not exceeding RM 500,000 or to imprisonment not exceeding five years, or both. The PSMA applies to safety matters as regards the transportation, and storage and utilisation of petroleum. The PSMA provides that no person shall store or handle any petroleum without obtaining a valid petroleum storage licence or valid petroleum handling licence granted under PSMA, authorising the storage or handling of petroleum in accordance with such conditions, if any, as may be attached to the licence.

It should also be noted that whenever any person under the PSMA or any regulation is liable to any punishment for any act, omission, neglect or default, he or she shall be liable to the same punishment for every similar act, omission, neglect or default of any agent or servant employed by him or her in the course of business as such licensed person, and every agent or servant employed by a licensed person under the PSMA in the course of business under such licences shall also be liable to every punishment or penalty prescribed for such act, omission, neglect or default contrary to the provisions of the PSMA as if such agent or servant had been the person to whom the licence had been granted.

The OSHA aims to, amongst other things, secure the safety, health and welfare of persons at work and protect persons at a place of work other than persons at work, against risks to safety or health arising out of the activities of persons at work. The OSHA is enforced by the DOSH and is applicable throughout Malaysia to the industries under the OSHA, which in respect of the oil sector, includes the petrochemical manufacturing.

HSE Requirements relating to Oil and Oil Product Composition

The bodies responsible for setting the standards for oil and oil product composition and regulating compliance with the standards are the Department of Standards Malaysia and the MDTCA respectively.

The EQA and PSMA and the relevant subsidiary legislation regulate the safety and environmental requirements in relation to oil and oil product composition. Non-compliance with these legislation may attract a fine or imprisonment, or both, upon conviction.

For example, the Environmental Quality (Control of Petrol and Diesel Properties) Regulations 2007 provides that a fuel supplier is responsible for the sampling and testing of each batch of fuel (i.e., petrol and diesel) after distillation, blending or import for prescribed properties under the Regulations. The sample and record collected must be kept for a period of six months from the date of sampling and such information must be provided to the Director General or any authorised officer as and when they request it.

Any persons who fail to perform the obligations stated above will be committing an offence and shall be liable to a fine not exceeding RM 50,000 or to imprisonment not exceeding two years, or both upon conviction.

In addition, all fuel suppliers in Malaysia must have a quality management system ensuring that when the fuel is delivered to a distributor, retail outlet or a bulk purchaser-consumer, the fuel complies with the properties as specified under the Environmental Quality (Control of Petrol and Diesel Properties) Regulations 2007.

Such quality management system must be documented and submitted to the Director General for his or her information and the Director General must be notified in the event that there are any changes to the quality management system.

Tax Laws and Regulations for Oil Exploration, Transportation and Marketing

Direct Taxes

The Inland Revenue Board of Malaysia (“IRB”) is the responsible regulatory body for the administration of direct taxes, whilst the Royal Malaysian Customs Department (“Customs”) administers customs and excise duties and sales and services tax.

The main tax legislation governing the oil sector are the Petroleum (Income Tax) Act 1967(“PITA”) and Income Tax Act 1967 (“ITA”). Under the PITA, petroleum income tax is chargeable at a rate of 38 per cent of the income derived by a chargeable person from petroleum operations.

‘Petroleum operations’ include, amongst others, the search for and winning or obtaining of petroleum in Malaysia and any sale or disposal of petroleum so won or obtained, including the transportation of the petroleum to any point of sale, delivery or export. The term excludes the following activities:

1. any transportation of petroleum outside Malaysia;
2. any process of refining or liquefying petroleum;
3. any dealings with products so refined or liquefied; or
4. services involving the supply and use of rigs, derricks, ocean tankers and barges.

For petroleum operations derived from a Joint Development Area, the chargeable income is subject to petroleum income tax at the rate of 0 per cent for the first eight years; 10 per cent for the next seven years; and 20 per cent for the subsequent years of production, provided that the prescribed conditions are complied with.

One of the tax incentives applicable to petroleum operations include, a tax exemption for a portion of chargeable income from marginal fields which results in a reduction of the effective tax rate from 38 per cent to 25 per cent for petroleum operations in marginal fields. ‘Marginal field’ is defined as a field that is determined by the Minister of Finance as a field in a petroleum agreement area which has potential crude oil reserves not exceeding 30 million stock tank barrels or natural gas reserves not exceeding 500 billion standard cubic feet.

As regards non-petroleum operations, the chargeable income derived from such activities are subject to the general tax regime under the ITA. This would include the midstream and downstream activities of refining, processing, transportation, marketing and distribution of petroleum and petroleum products, which would be taxable in accordance with the ITA.

Currently, resident and non-resident companies are taxed at the rate of 24 per cent, except for those with paid-up capital of RM2.5 million or less which are taxed at 17% only for the first RM600,000 of income and any excess of RM600,000 at the rate of 24%.

Other Applicable Taxes and Customs Duties

The Sales and Service Tax regime, which has replaced the Goods and Services Tax regime (which was effective from 1 April 2015) on 1 September 2018, may also be applicable to the oil sector. Sales tax is a single-stage tax imposed on taxable goods manufactured or imported into Malaysia, while service tax is a consumption tax levied and charged on any taxable services provided in Malaysia by a registered person.

Stamp duty is chargeable on instruments in accordance with the Stamp Act 1949 and ranges from RM10.00 to ad valorem rates. The Customs Act 1976 and its regulations and orders are applicable to cross-border sales and deliveries of crude oil and crude oil products. Export duties are generally imposed on Malaysia’s main export commodities such as crude petroleum. Exportation of certain classes of petroleum products may also require an export licence.

Commodities Price Control

The MDTCA is empowered by the Price Control and Anti-Profiteering Act 2011 (“PCAPA”) to make orders regulating the maximum, minimum or fixed price for the manufacturing, producing, wholesaling or retailing of any goods.

In Malaysia, the retail prices of petroleum products, such as petrol, diesel and liquefied petroleum gas, is set through an automatic fuel pricing (“AFP”) mechanism. Since 1 December 2014, the prices of petrol and diesel have been fixed on a managed float system.

With effect from 1 January 2019, the Government of Malaysia has decided to reinstate the former weekly price-float mechanism whereby fuel prices are determined on a weekly basis70. The MDTCA also issued the Price Control and Anti Profiteering (Determination of Maximum Price) (No. 4) Order 2015 which sets the maximum price at which liquefied petroleum gas can be transacted at by producers, wholesalers and retailers. The maximum retail prices for petrol and diesel are also provided under the Price Control and Anti-Profiteering (Determination of Maximum Retail Price For Petrol And Diesel) (No. 45) Order 2019.

Under the PCAPA, it is an offence to buy and sell liquefied petroleum gas above the price set by the order. Upon conviction, the person shall be liable to a fine not exceeding RM 500,000 and RM 1 million for subsequent offences if committed by a body corporate71. For nonbody corporates, the penalty is a fine not exceeding RM 100,000 or imprisonment for a term not exceeding 3 years, or both, and for subsequent offences, a fine not exceeding RM 250,000 or imprisonment of 5 years, or both.

Labour Laws and Regulations

The Employment Act 1955 (“EA”) applies only to employees whose wages do not exceed RM 2,000 a month and certain categories of employees irrespective of their wages, such as manual labourers, supervisors of manual labourers, drivers, domestic servants, etc. For those who do not fall under this category, their rights are dependent on the terms of their contract of employment.

Under the Employment (Exemption) (No. 2) Order 1997, Petronas and any of its contractors and subcontractors provided that they are engaged in activities in the upstream oil sector will be exempted from the compliance of certain provisions of the EA. Such exemption applies to the employees of Petronas and its contractors and subcontractors of the contractors, whose place of work is within the territorial waters or the Exclusive Economic Zone or the Continental Shelf of Malaysia.

Foreign workers may only be employed provided that they have been issued a valid employment permit under the Employment (Restrictions) Act 1968. Failure to comply with such requirement may on conviction result in the employer of the foreign worker being liable to a fine not exceeding RM 5,000 or to imprisonment for a term not exceeding one year or both. Further, it is also an offence, pursuant to the Immigration Act 1955, to employ a foreign worker who is not in possession of a valid pass.

Generally, for the purposes of an application of a Petronas licence, the company must amongst other things, meet a prescribed minimum bumiputra requirement for equity and composition of Board, management and employees, where applicable, based on the relevant SWEC Code. For example, if the minimum bumiputra requirement for a certain SWEC Code is 30%, amongst other things, 30% of the employees of the entity shall comprise of bumiputra individuals.

As of 1 June 2015, the Construction Industry Development Board (“CIDB”) requires skilled construction workers who are working in any of the 25 skilled trades as listed in the Lembaga Pembangunan Industri Pembinaan Malaysia Act (“CIDB Act”) to be accredited and certified by CIDB and holds a valid certificate issued by the CIDB under the Act. In relation to the oil and gas industry, these include riggers, scaffolders and chargemen.

Competition Laws and Regulations of Oil Sector

The Malaysian Competition Commission (“MyCC”) enforces the Competition Act 2010, which generally applies to commercial activities in Malaysia or commercial activities conducted outside of Malaysia which has an effect on competition in any market in Malaysia.

All commercial activities regulated under the PDA which are directly in connection with upstream operations comprising the activities of exploring, exploiting, winning and obtaining petroleum whether onshore or offshore of Malaysia are, however, exempted from the Competition Act .

Petronas is the regulator of all upstream activities. On the other hand, MyCC is the regulator having the authority to both prevent and punish anticompetitive practices in connection with non-upstream activities, such as the transportation and marketing of crude oil or crude oil products.

International Treaties

International treaties signed by Malaysia have no domestic legal effect, unless the Parliament passes a law to give effect to the treaties. An example of a statute which was passed by Parliament to give effect to a treaty concluded by Malaysia, is the EEZA which gives effect to certain provisions of the United Nations Convention on the Law of the Sea 1982.

Some other treaties that Malaysia has signed are of particular relevance to the oil sector and they include:

1. the London Convention 1972/1996;
2. the Geneva Convention on Continental Shelf 1958;
3. the United Nations Convention on the Law of the Sea 1982;
4. the International Convention for the Prevention of Pollution from Ships, 1973 and its 1978 Protocol;
5. the International Convention on Oil Pollution Preparedness, Response and Co-operation 1990;
6. the International Convention on Civil Liability for Oil Pollution Damage, 1992; and
7. the International Convention on the Establishment of an International Fund for Compensation for Oil Pollution Damage 1992.

Malaysia has, to date, signed 71 bilateral investment treaties (“BITs”), of which 54 are in force. BITs signed by Malaysia typically includes clauses such as “fair and equitable treatment”, “protection from expropriation” and “Most Favoured Nation” (“MFN”) which, amongst other things, provide for broad guarantees of treatment or protection for investors. For example, the MFN clause ensures parties to a treaty provide treatment no less favourable than the treatment they afford to investors under other treaties.

Enforcement of Foreign Arbitral Awards

Malaysia is a party to the Convention on Recognition and Enforcement of Foreign Arbitral Awards 1958 (“New York Convention”), which requires courts of contracting states to recognise and enforce arbitration awards made in other contracting states.

Section 38 of the Arbitration Act 2005 (“AA”) provides for the procedure for recognition and enforcement of awards where the seat of arbitration is in Malaysia, or where the award is from a state which is a contracting party to the New York Convention.

A party who seeks to enforce such arbitral award must apply to the High Court to have the award recognized as binding. Upon such recognition by the High Court, the award may be enforced as if it were a court judgment in terms of the award. The AA also provides for grounds upon which such recognition or enforcement of an award may be refused at the request of the party against whom it is invoked.

Examples of such grounds include, but are not limited to:

1. the award being in conflict with the public policy of Malaysia;
2. the subject matter of the dispute is not capable of settlement by arbitration under the laws of Malaysia; or
3. a party to the arbitration agreement was under an incapacity.

If you have any questions or require any additional information, please contact our lawyer that you usually deal with.

This article is written by our Principal Associate, Chakaravarthi