Since the country gained independence in 1957, Malaysia’s economic activities have shifted from primary commodities such as rubber and wood to industrialization over the years. To meet the growing needs of the business communities in terms of manufacturing and trading facilities and to attract more foreign direct investment, the Malaysian Government enacted the Free Zones Act 1990 which was gazetted on May 10, 1990. The activities within the Free Zone are governed by the Free Zones Regulations 1991.
As stated in section 3(1) of the Free Zones Act 1990, the Minister of Finance may declare an area to be a free zone. A free zone refers to a secured and designated area where commercial and industrial activities are conducted with minimal customs control and deemed to be a place outside of Malaysia that is not subject to the applications of the Customs Act 1967, Excise Act 1976, Sales Tax Act 2018 and Service Tax Act 2018, except in cases where imports and exports are prohibited under Section 31 of the Customs Act 1967. However, the movement of people and goods into and from the free zone are strictly controlled.
The Minister of Finance may appoint any statutory body established under the laws of the Federal Government of Malaysia or a state government, or any company as a Free Zone Authority, to manage, maintain and operate any Free Zone. Companies intending to operate in the Free Zone (which may be 100% owned by foreign investors) must obtain prior approval from the Free Zone Authority.
Currently, the main activities in the Free Zone include the electronics and electrical industry, petrochemicals, food, plastics, medical equipment, general assembly industries, services, logistics, warehousing, and e-commerce etc.
There are two types of the free zone, that is i) Free Industrial Zone for companies carrying on manufacturing activities, and ii) Free Commercial Zone for companies carrying on commercial activities.
Free Industrial Zone (FIZ)
To qualify for operation in a FIZ, the company has to export at least 80% of its output and its raw materials/components are mainly imported. If a company in the FIZ has obtained approval from the Ministry of International Trade and Industry (MITI) to reduce its export condition to 60%, it may also apply to the Customs for permission to export 60% of its output instead of 80%.
Companies operating in the FIZ are entitled to duty-free importation of raw materials, including packaging materials and machinery and equipment used directly in the production of the products specified in their manufacturing licenses (unless such manufacturers are exempt from applying for a manufacturing license). Companies in the FIZ are also exempt from excise, sales and service taxes. However, raw materials or components that are not directly used in the manufacturing process will not be entitled to the abovementioned duties/exemptions, such as: fuel, office furniture and equipment (including food and beverages), air conditioners, vehicles and spare parts, construction materials, forklifts, fire fighting equipment, pollution control equipment, and employee dress code.
As FIZ is deemed to be outside of Malaysia, any goods taken out of the FIZ into the Principal Customs Area (PCA) of Malaysia are deemed to be imported into the country and will be subjected to the payment of the prevailing customs duty, excise duty, and sales tax. As companies in FIZ will export at least 80% of their output, they are allowed to sell a maximum of 20% of their output into PCA. The goods manufactured from FIZ and brought into PCA are considered imported goods and therefore the goods must be declared as imported on Customs Form No. 1. Likewise, any goods brought into FIZ from PCA are considered to be exports and should be declared on Customs Form No. 2.
Companies operating in FIZ are permitted to send the semi-finished goods and raw materials to another factory located in another FIZ, Licensed Manufacturing Warehouse (LMW) or in the PCA, for specific processes and subsequently return to the company in FIZ provided that approval from the State Director of Customs is obtained in advance.
Companies operating in FIZ are responsible for keeping proper records of all activities at their premises, including goods received at the premise and taken out to the PCA, waste stock, and method of disposal with the written approval of the Free Zone Authority after consultation with the Customs Department. At the same time, the Customs Department is entrusted with controlling the movement of goods at the entry and exit points, with the authority to search the premises, vehicles and personnel, and has the authority to arrest and seize goods.
There are currently 21 FCZ in Malaysia, which are mainly in the State of Johor, Melaka, Pulau Pinang, Selangor, Perak, and Sarawak.
Free Commercial Zone (FCZ)
The Malaysian government established the FCZ to promote commercial and trading activities in Malaysia, including entrepot trade, in conjunction with the promotion of the services sector. Due to the nature of the activities, FCZs are usually located near Malaysian ports to facilitate bulk dismantling, repackaging of products that are either imported or procured from FIZ or LMW or PCA’s companies. For all imports will be subsequently re-exported together with other products or composed as another product repackaged in the FCZ, companies operating in the FCZ are exempted from paying import duties, excise taxes, sales taxes and service taxes, similar to FIZ.
The companies in FCZ are not allowed to carry out retail trade with the exception of FCZ in Rantau Panjang Free Zone in Kelantan, Bukit Kayu Hitam Free Zone in Kedah, and Stulang Laut Free Zone in Johor.
There are currently 21 FCZ in Malaysia, which are mainly in the State of Johor, Melaka, Kelantan, Pulau Pinang, Kedah, Selangor, Kuala Lumpur, Terengganu, Pahang and Sabah.
Disadvantages of Free Zone
Even though there are many advantages, particularly in respect of exemption of duty/tax upon the importation of materials, goods or equipment can be enjoyed by the companies operating in the free zone, there are certain disadvantages or shortcomings, which include:
1) The need to comply with a comprehensive regulatory system, with the Customs Department having the right to conduct regulatory audits;
2) High paid-up capital requirement depending on business activities;
3) Specific permits or licenses required; and
4) maintain an office in the free zone which may increase the operating costs.
The establishment of a free zone in Malaysia has helped to establish a more conducive and competitive business environment for companies operating in Malaysia and help attract more foreign direct investment. In addition, Malaysia has benefitted from free zone in terms of technology transfer, skills training, development of local ancillary industries, and development of capital and technology intensive industries among others.