OUR THOUGHTS ON THE LABUAN'S REVAMPED TAX FRAMEWORK AND SUBSTANCE REQUIREMENTS

April 25, 2019


When it comes to choosing the right jurisdiction for your “offshore company”, for some reason Labuan may not be at the top of your list. Either the costs are dearer compared to other well-known jurisdictions that offer very reasonable pricing or it is just not as coveted as other IFCs such as the BVI, Cayman Islands, Panama or the Channel Islands, etc. But if your trade focus is in the region, Labuan is worth checking out as it is centrally located in South-east Asia planked by the region’s financial giants like Singapore, Bangkok, Kuala Lumpur, and China’s southern region including Hong Kong. Other significant advantages are that Labuan offers business conduits with low tax rates as an incentive, coupled with cheaper overall costs of doing business and decent living standards.

Although Labuan is like a state on its own but it is not entirely independent. The island is one of the three federal territories of Malaysia. As with all state matters, it is governed directly by the federal government sitting in Putrajaya. However, regulations pertaining to business entities formed in Labuan are directly supervised by the local regulator namely Labuan FSA. Corporate taxes are regulated by the country’s Inland Revenue Board but it has a specific legislation covering business activities carried out by Labuan business entities in, from and through the island territory.

This article is to refresh our thoughts whether can Labuan still be attractive and affordable after it rolled out its revamped tax policy and substance requirements all within a few weeks in order to meet the deadline by the OECD and notably the EU.

Labuan’s low corporate tax remains attractive

Depending on the type of business activities, the tax rates are at 0% for non-trading activities and 3% on net audited profit for trading activities under the Labuan Business Tax Act 1990 (LBATA). “Non-trading” business activity can be holding of investments, for example holding of equities, stocks, bonds, intellectual property rights or a whole of other investment funds. Holding of shares or equities in an underlying company is included under non-trading category. Whereas a “trading” activity can be a business dealing such as retail and wholesale of goods, or services like consultancy or management, etc.

Basically, if you engage in a non-trading activity you enjoy the 0% tax rate, subject to your Labuan company satisfying the substance requirements. We write about the substance requirements more in another paragraph. If you are carrying on a trading activity, you enjoy the 3% tax rate.

However, starting from 1 January 2019, Labuan companies holding IP rights will be taxed at 24% and dealt under the domestic income tax regulation, the Income Tax Act 1967 (ITA).

Labuan’s amended tax framework came into force and substance regulation passed

Alongside with the introduction of economic substance regulation, the Malaysian Government has also made significant amendments to its Labuan tax regime. Highlights to some of the changes include the removal of the RM20,000 flat tax rate as well as Labuan entities can now transact freely with residents of Malaysia and trade in Ringgit Malaysia while retaining its 0%-3% tax rates incentive. This initiative has eliminated the ring-fencing element from the jurisdiction.

This commitment has rated Labuan as “not harmful” and “largely compliant” by the OECD. As part of the BEPS compliant where the economic substantial concern has been addressed, Labuan entity carrying on a “Labuan business activity” is now required to fulfil certain economic substance requirements in order to benefit from the preferential tax rates.

Labuan business activities, according to the Labuan Business Activity Tax (Requirements for Labuan Business Activity) Regulations 2018 include –

  • Labuan insurance and takaful businesses
  • Labuan international commodity trading companies
  • Labuan banks
  • Labuan trust companies
  • Labuan leasing companies
  • Labuan credit token companies
  • Labuan development finance companies
  • Labuan building credit companies
  • Labuan factoring companies
  • Labuan money brokers
  • Labuan fund management companies (including securities licensee and fund administrators)
  • Labuan company management
  • Labuan international financial exchange
  • Self-regulatory organisation (such as a Labuan PCC)
  • Holding company

The Government’s gazetted regulation prescribes the minimum requirements on economic substance to be met, in correspondence with the entities’ category of business activities. Click link here for the minimum requirements set out in the Gazette. Whilst the new regulation on economic substance requirements mostly affects Labuan licensed entities, and they must already meet the minimum physical requirements due to their licensing conditions. However, with the new substance regulation, the drawback would be that all managed trust companies and those insurance firms managed by their managers in Labuan are now also captured under the substance regulation. They are now required to demonstrate substantial economic activities in Labuan starting 1 January 2019.

Although holding company is not a regulated business, it is also caught under the substance regulation. Part of our focus in this section is to touch on the requirements for substance for Labuan holding companies. Question arises, is Labuan still a viable conduit for business activities, in particular investment holding companies, with all the rising costs and compliance stemmed from this new regulation? We will publish soon in the next article with some scenarios using Labuan companies to explore with you. Please be reminded that one size does not fit all. We would like, however to share with you on how to capitalise with fulfilled substance requirements using Labuan companies in our next article.

So, a Labuan entity carrying on a “Labuan business activity” which does not meet the substance requirements will not be able to benefit from the low tax rates offered under the LBATA and it will automatically be taxed at a standard headline rate of 24% under the ITA.

Commencement date

Labuan entities doing Labuan business activities that existed before 1 January 2019 must comply with the economic substance requirements effective from 1 January 2019. New Labuan entities incorporated from 1 January 2019 onwards will need to comply with the substance requirements from the date they commence their Labuan business activities.

Business as usual, but with a change

Labuan jurisdiction is a very welcoming region for cross-border business community. Moreover, Labuan provides balance between client confidentiality and compliance with international best standards and practices with evidence of its commitment on due diligence requirements in combating money laundering and terrorism financing activities, greater tax transparency and fulfilling the economic substance requirements. With that said, Labuan still retains its attractiveness by leveraging on cost effective for business operations and low tax incentives as compared to other jurisdictions in the region.

Last Updated: May 15, 2019