Question 2

Federalism guarantees financial autonomy for both federal and state governments. In
accordance with this principle, the Federal Constitution has been designed to provide financial
independence to the state governments to enable them to govern themselves without relying on
the federal government.

Discuss the financial sources for the states including Sabah and Sarawak. Do you think the sources
of income for the states are sufficient and adequate for them to be independent of the federal
government?
SUBJECT MATTER : WRITTEN SUBMISSION FOR TUTORIAL PRESENTATION

TO : ASSISTANT PROFESSOR NOR HAFIZAH MOHD. BADROL AFANDI

FROM : GROUP 1 TUTORIAL MONDAY 3-4 PM

NOR ALBINA ALLESEANA BT MOHD JAIB (1528942)

NUR AMALINA BT AZAMI (1528110)

NUR AFIQAH MOHAMAD SAKRI (1526900)

Malaysia subscribes Parliamentary Democracy and Constitutional Monarchy which is

founded based on the principle of Federalism. In general, federalism concept is an administrative
system which the states unite under one central authority. William H Riker in defining federalism
provides 3 characteristics that are normally attributed to the concept, inter alia, two levels of
government that rules the same land and the same people, both being autonomous in at least
one area of action and lastly, the constitution guarantees the autonomy of the respective
government in its own sphere. In discussing about the separation of power between the central
and state government, this can be related to the demarcation of financial powers between the
central and state government under the Malaysian constitution. The balance is tilted heavily in
favour of the Central government as the latter controls most of the lucrative sources of revenue.
However, the Constitution neutralized such imbalance by allocating specific revenues that the
state government is able to benefit from.

In Article 109(1), the Constitution guarantees specific money reimbursements to the

states which can be divided into two; Capitation Grants and State Road Grants. The Capitation
Grant as provided in Article 109(1)(a) of FC is a sum amount of money granted by the federation
to the state based on population census taken at the beginning of each financial year. The
method of calculating the annual grant has been drawn in Part I of Tenth Schedule of the FC
which provides RM72 per person for the first 100 000 people, RM 10.20 per person for the next
500 000 people and RM10.70 for the next 500 000 and lastly, RM 11.40 per person for the
remainder. This grant aims to assist the state government in meeting their financial requirements
as well as to achieve fairer distribution of wealth for the poorer states by assuming that the less
populous states are relatively poor states.

As for the State Road Grant, it is established under Article 109(1)(b) the Federal
Constitution which intended to assist the State governments in maintaining state roads.
Generally, state roads are any public road other than what is defined in Federal Road Ordinance
1959 which the public has access to including municipal roads, roads to low cost housing areas
and back lanes. The method of calculating the amount payable by federation is provided in Part
II of the Tenth Schedule of FC. It should be emphasized that both grants are mandatory payments
and the federal government has no discretion to withhold payment.

Article 110 to be read together with Part III of the Tenth Schedule provides 14 matters
which the states are given power to derive its revenues by imposing taxes and fees. The most
lucrative among all is the income derived from natural resources such as land, mines and forest.
In Article 110(3) of FC, the states are entitled to receive a proportion amount of revenues
collected by the Federal government from the export duty of minerals which are mineral ores,
metal and mineral oil.

The federation also has the duty to provide Conditional Grant which is to be used by states
for a specific purpose. The central authority allocates certain amount of money to supplement
the states own domestic revenue and to help the states to meet their financial requirement. For
example, to support important and big events or functions like SUKMA. Under Article 103 as well
as Article 109(5) of the FC, the Parliament may create by law a grant known as Contingencies
Fund. The Minister of Finance, if satisfied that there has an arisen urgency and unforeseen need
for expenditure by the States, may make an advances from the Contingencies Fund to meet that
need. If he had make any advances, he must later seek parliamentary authority to replace the
amount advanced. Among examples of such situations are like flood or any natural disasters.

In addition to the said funds, the federation must also pay into a fund known as the State
Reserve Fund a sum of money determined to be necessary after consultation with the National
Finance Council at the beginning of each finance year. The main purpose of the fund is to
supplement the general revenue of state government which is facing current account deficits,
particularly for the purpose of developing the state. Such grants have been made to Kedah,
Kelantan and Perlis.

Another source where the state can obtain revenues is through loan but the question is,
to what extent does the constitution allows this? It has been provided specifically in Article 111
of the FC, the restrictions upon the states to raise or borrow money except from the federation
or a federally approved bank. In the case of Government of Malaysia and Government of
Kelantan, the defendant had negotiated a clever financial arrangement with a private company
which advanced RM 2.5 million to it in return for mining and forest concessions. The Federal
Court rejected the contention of the plaintiff which claimed the arrangement constituted
borrowing and therefore had violated Article 111 of FC. The court held that there was lacking of
legal relationship of lender and borrower between the state and the cooperation and the state
was not obliged to repay even if the advance payment were forfeited for breach of conditions.
Due to this particular case, the term borrow in Article 160(2) of FC has been amended so that
pre-payment of royalties will now constitute borrowing.

Due to the special needs of the states of Sabah and Sarawak resulting from the size as
well as the potential resources of these regions, they enjoyed other sources of revenues that
were not permitted to other states. This special position of Sabah and Sarawak can be equalized
with the position of Kashmir in the federation of India which, also, has a high economic potential
and was given a special position in terms of agriculture and horticulture. Generally, the fiscal
privileges that Sa-bah and Sarawak enjoyed can be divided into 3 main areas which are the special
grants by federation, the import and excise duty and last but not least the borrowing powers.

In regards to the first mentioned area, the Borneo states of Malaysia are entitled to
certain other grants that are not available to states on Peninsular as provided under Article 112C
of the Federal Constitution and specified in Part IV of the Tenth Schedule. They are allocated
these special grants to meet their needs above and beyond what other states receive. In the case
of Sarawak, a grant of RM5, 800,000 known as the Annual Balancing Grant is to be given at the
beginning of each financial year. Apart from this, Sarawak is also entitled to Annual Escalating
Grant which the amount differs in each financial year as it is fixed based on the review under
Article 112D. It shall also be noted that both grants are subjected to a periodic review to be
carried out every five years or longer as laid down in Article 112D of Federal Constitution. As for
the state of Sabah, the federation has the duty to make a grant known as Growth Revenue Grant
which is payable according to two fifths of the net revenue derived by the Federation from the
state. Similar to the case of Sarawak, the Growth Revenue Grant is also subjected to a review
every five years or longer as mentioned in Article 112D of the Federal Constitution.

In addition to this, Sabah and Sarawak are also assigned with eight additional sources of
revenues not permitted to others which are provided under Article 112C and Part V of the Tenth
Schedule. These revenues among others also include import and excise duties of natural sources
which are petroleum products, timber and forests produce as well as of minerals. Other than
that, Sabah and Sarawak can source their revenues through fees from road vehicles or licenses
connected with those vehicles and also fees from the registration of mechanically propelled
vehicles. The states also are entitled to receive the taxes and fees from water rates and license
connected with water supplies and services. Besides that, the additional revenues of Sabah and
Sarawak are the fees and dues from the states ports and harbors, state sales taxes and lastly,
duties from medicine and health custom revenues.

Last but not least, the general rule of restriction on the states to raise or take up loans
from other sources than the federation or any federal approved bank as provided in Article 111
does not apply in West Malaysia. The exception to the general rule is stated in Article 112B of
Federal Constitution which gives power to the states of Sabah and Sarawak to have a wider
borrowing power as they can make loans from any sources as long as they received approval
from the Central Bank or Bank Negara.