The recent Court of Appeal decision in Pemungut Duti Setem Malaysia v Perbadanan Pembangunan Pulau Pinang (Civil Appeal No: K-01(NCvC)(A)-809-12/2021) addresses the issue of whether a Letter of Undertaking (“LOU”) issued by the Penang State Government to the Ministry of Finance (“MOF”) constitutes a security under the Stamp Act 1949 (“the Act”). The classification of the LOU as a security adversely impacts the eligibility for stamp duty remission under the Stamp Duty (Remission) Order (No. 2) 2012¹ (“the Remission Order”). Under the Remission Order, the amount of stamp duty that is chargeable under item 22(1)(b) of the First Schedule to the Act upon a loan agreement or loan instrument without security for any sum or sums of money repayable on demand or in single bullet repayment under that item which is in excess of 0.1% is remitted. This decision has significant implications for the interpretation of state guarantees and their treatment under Malaysian stamp duty law.
 
The Penang Development Corporation (“PDC”), a state entity, obtained a RM100 million Islamic Tawarruq banking facility from Bank Islam Malaysia Berhad (“BI”). A MOF Directive dated 19 November 1999 required state governments to fully guarantee any loan obtained by a state entity such as PDC. Consequently, the Penang State Government issued an LOU dated 9 August 2019 to the MOF, undertaking to be accountable for the RM100 million facility granted by BI to PDC. This LOU became the focal point of dispute—whether it amounted to a "security," thereby disqualifying the financing agreement from stamp duty remission under the Remission Order. The conditions stipulated in the Letter of Offer dated 6 May 2019 between BI and PDC included the submission of the LOU from the Penang State Government to the MOF as a condition precedent.
 
Following compliance with the conditions in the Letter of Offer, PDC and BI entered into the financing agreement on 1 September 2020. Thereafter, PDC applied for a remission of stamp duty on the financing agreement under the Remission Order. The Collector of Stamp Duties (“the Collector”) rejected the application and issued a security estimation notice (ad valorem duty) on 24 September 2020, confirming the duty payable on the financing agreement.
 
High Court Decision
 
PDC appealed the Collector’s decision to the High Court under Section 39 of the Act. The High Court ruled in favour of PDC, determining that the LOU did not constitute a security. The decision was based on the precedent set in Muhibbah Engineering (M) Bhd v Pemungut Duti Setem [2017] 10 CLJ 66 (“Muhibbah Engineering”), where it was held that a negative pledge did not amount to a security for stamp duty purposes. The High Court also adopted the definition from Muhibbah Engineering, emphasising that a security must be an encumbrance over the debtor’s property, which the creditor can enforce to recover the loan in case of default. The LOU did not meet this criterion as it did not provide BI with any enforceable rights over PDC’s assets.
 
The High Court held that the LOU was essentially a letter of assurance from the Penang State Government to the MOF, without creating an encumbrance on any property that BI could rely on to enforce repayment. There was no privity of contract between BI and the MOF. Hence, the High Court concluded that the LOU did not fit the definition of "security" under the Act. Consequently, the financing agreement was eligible for stamp duty remission under the Remission Order.
 
Court of Appeal Decision
 
The Court of Appeal allowed the Collector’s appeal and overturned the High Court's decision, concluding that the LOU did, in fact, constitute a security. The Court of Appeal emphasised that the LOU provided “a clear assurance that the State Government would take full responsibility for the loan amount”, effectively guaranteeing the repayment of the RM100 million facility to BI. The Court distinguished the present case from Muhibbah Engineering, noting that the negative pledge in that case did not create a security interest, whereas the LOU in the present case provided a direct assurance of payment. In arriving at this decision, the Court of Appeal also opined that Muhibbah Engineering did not seek to apply a restrictive definition to the word security. Therefore, the broader interpretation of "security" should be applied. Other definitions of “security”, including those found in Stroud’s Judicial Dictionary of Words and Phrases and Black’s Law Dictionary were considered. The definitions state that “security” encompasses anything that assures or guarantees the repayment of money, whether through an encumbrance on property or other means.
 
In the opinion of their Lordships, even though the LOU is a letter between the Penang State Government and the MOF, it explicitly secures the repayment of the loan facility to BI. As a result of this assurance provided to the MOF, the payment of the RM100 million facility is guaranteed by the Penang State Government. The Court noted that BI is a Government-Linked Company of the Federal Government, while PDC is a state entity. It added that the relationship between BI and PDC is not strictly commercial but is instead guided by government policies. Thus, BI had specified the requirement of a LOU from the Penang State Government, in compliance with Federal Government policy instead of the usual securities in the form of mortgages or charges.
 
The Court of Appeal allowed the appeal and concluded that the LOU provided by the Penang State Government constituted a security for the financing agreement. Although the LOU did not create an encumbrance on property, it provided a strong guarantee from the Penang State Government, ensuring the repayment of the loan and thus constitutes a form of security. Consequently, the financing agreement did not qualify for stamp duty remission under the Remission Order.
 
Commentary
 
The Court of Appeal's decision in this case redefines the understanding of "security" within the context of state-backed loans from the perspective of stamp duty. The High Court's narrow interpretation focused on traditional forms of security—encumbrances on property—while the Court of Appeal adopted a broader view, considering the implications and the purpose of the LOU.
 
As the parties had mutually agreed that the Court of Appeal was not required to consider the issue of enforcement of the LOU, the practical (and problematic) issue as to how BI, which is not a party to the LOU, would enforce the security remains unanswered.
 
This decision also suggests that entities seeking stamp duty remission under the Remission Order should carefully consider the nature of any undertakings or guarantees provided in support of unsecured loans repayable on demand or by a single bullet repayment.
 
PDC has obtained leave to appeal the decision to the Federal Court. It is hoped that the appeal will provide a definitive ruling as to whether a guarantee or assurance of payment given by a state government to the MOF in connection with a loan granted by a third party to a state entity is a security for the purposes of stamp duty.
 
Case Commentary by Victoria Low (Associate) of the Tax Practice of Skrine.
 

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