Mid-Shore Business Incorporation in Labuan: A Sudden Tax Curveball?

Labuan Entities will be subjected to a tax rate of 24% for Assessment Year 2020

Located off the coast of Sabah in East Malaysia, Labuan was designated an international financial centre with a mid-shore jurisdiction in 1990 offering a wide range of business and investment structures facilitating cross-border transactions, business dealings and wealth management needs. These unique qualities offer sound options for regional businesses going global or global businesses looking at penetrating Asia’s thriving markets. In 2008, its name was changed to Labuan International Business and Financial Centre (Labuan IBFC).

The jurisdiction has moved beyond banking, capital markets, leasing and insurance to also include private company, partnerships, trusts, foundations and an international shipping registry, among others. There are two types of companies in Labuan trading and non-trading/holding, incorporated under the same law but with different taxes and audit requirements. But a recent sudden revision in the tax regulations have sent distress signals to the business community in Labuan. In this article, we will focus on these amendments and their impact on the Labuan entities.

But first let us understand the several factors that made Labuan IBFC attractive to the international business community.

Strategic location and a well-regulated jurisdiction

Labuan IBFC’s jurisdiction adheres to international standards and it follows the best practices in financial services as set by the government. It includes the regulatory requirements established by the Organisation of Economic Co-operation and Development (OECD). A company listed under Labuan IBFC will be tax compliant as Malaysia has adopted OECD international standard of transparency.

Simple tax structure

Labuan IBFC implements a simple tax framework under the Labuan Business Activity Tax Act 1990, which covers Labuan business activity carried on by a Labuan entity in, from or through Labuan.

A unique 3% tax rate is charged on the yearly assessment of the net audited profits of the company carrying on a trading activity.

In the instance of a Labuan entity carrying on a non-trading activity, no tax will be applied for that assessment year. A Labuan non-trading activity is defined as activity relating to the holding of investments in securities, stocks, shares, loans, deposits or any other properties situated in Labuan and held by a Labuan entity on its own behalf while a Labuan trading activity includes banking, insurance, trading, management, licensing, shipping operations or any other activity.

Labuan company registration if properly structured, is a legitimate tax-exempt way of conducting business in the areas of offshore banking, insurance, trust and fund management and investment holding. Furthermore, as part of Malaysia, a Labuan company can access the double tax treaties Malaysia has signed with a range of countries.

New Changes in the Labuan Tax Legislation

In November 2018, the Finance Minister announced several revisions in the 2019 budget.

  • No restriction on dealing with Malaysian Ringgit or Malaysian residents. It is now possible for a Labuan entity to carry on a ‘Labuan business activity’ in Malaysian Ringgit and with a Malaysian resident.
  • Income from intellectual property no longer taxed under LBATA. Income generated from intellectual property (IP) assets held by a Labuan entity will be subject to tax rate of 24% under the Malaysian Income Tax Act 1967 and can no longer be taxed under the Labuan tax.
  • Abolishment of election to pay tax at the flat rate of RM 20,000 per year.Previously a Labuan entity undertaking a ‘Labuan trading activity’ had the option of electing to pay tax at the rate of 3% on its net profits per year as reflected in its audited accounts or choose a flat rate of RM 20000 per year. But with effect from 1st January 2019, companies will be automatically subject to tax at the rate of 3% on their net profits as reflected in its audited accounts. Consequently, all Labuan entities are now required to have audited accounts for the purpose of tax filings.That being said, a Labuan entity performing a “Labuan non-trading activity” continues to be exempt from tax with no requirement to maintain audited accounts
  • New economic substance requirements for Labuan entities.To improve compliance with the OECD and BEPS requirements, a Labuan entity carrying on a “Labuan Business Activity” (see the below chart) is now required to demonstrate economic substance with an adequate number of full-time employees and an adequate amount of annual operating expenditure in Labuan.These Economic Substance Regulation under the Labuan Business Activity Tax Regulations 2018 [P.U. (A) 392/ 2018] prescribes the minimum requirements on economic substance to be met, in correspondence with the entities’ category of business activities (cf. fig.1).Labuan businesses failing to comply for a basis period for a year of assessment (YA) shall be taxed at the rate of 24% upon its chargeable profits. Effective 1st January 2019, existing Labuan and newly incorporated entities will need to comply with the substance requirements.

Labuan Business Activity Tax Regulations 2018 Chart

No.
Labuan entity carrying on a Labuan business activity
Minimum number of full time employees in Labuan
Minimum amount of annual operating expenditure in Labuan (RM)

1

Labuan insurer or reinsurer, Labuan takaful orretakaful operator

4

150,000

2

Labuan underwriting manager or takaful manager

4

100,000

3

Labuan insurance manager or Labuan takaful manager

4

100,000

4

Labuan insurance broker or Labuan takaful broker

4

100,000

5

Labuan captive insurer or Labuan captive takaful

4

100,000

6

Labuan International Commodity Trading Company

3

3,000,000

7

Labuan bank or investment bank, Labuan Islamic bank or investment bank

3

180,000

8

Labuan trust company

3

120,000

9

Labuan leasing company or Labuan Islamic leasing company

2

100,000

10

Labuan credit or Islamic credit token company

2

100,000

11

Labuan development or Islamic development finance company 

2

100,000

12

Labuan building or Islamic building credit company

2

100,000

13

Labuan factoring or Islamic factoring company

2

100,000

14

Labuan money or Islamic money broker

2

100,000

15

Labuan fund manager

2

100,000

16

Labuan securities or Islamic securities licensee

2

100,000

17

Labuan fund administrator

2

100,000

18

Labuan company management

2

100,000

19

Labuan International Financial Exchange

2

120,000

20

Self-regulatory organisation or Islamic self-regulation organisation

2

120,000

21

Holding Company

2

50,000

A Lack of Clarity

While the list provided by this regulation seems mostly affecting Labuan licensed entities, the definition of “Labuan business activity” is broad and invite the following questions:

  • Is this revised regulation applicable to Labuan entities which are not listed specifically in the Economic Substance Regulations?
  • If yes, then to what extent? Would the non-listed Labuan entities be penalised with 24% rate even if they comply with the requirements?
  • Does complying with Economic Substance Regulation automatically mean satisfying the obligations of a Labuan entity to meet ‘adequate’ requirements under section 2B (1)(b) of the Labuan Business Activity Tax Act irrespective of the size of operations and assets of the Labuan entity?

Further Clarification Provided – or is it? 

Following the recent amendments in the Labuan Tax Legislation, the relevant authorities have issued and put forward the following clarifications.

All Labuan Entities will be subjected to a tax rate of 24% for Assessment Year 2020 (earnings from January 1st to December 31st, 2019) except for the following:

  • License Labuan Entities as per list in gazette dated 31st January 2018 (P.U.(A) 392/ 2018)
  • Pure equity holding
  • Investment holding of properties in Labuan.

To read more on this, please click on the link: https://www.labuanibfc.com/

Wavering Trust: Will Labuan Lose its Best Feature?

These changes would impact the more general trading business that are not listed on the regulation such as eCommerce, consultancy services, import /export, etc.

Since these activities are not in the list requiring the substance:

  • They will be taxed at 24% of their net profit even if there are compliant with the substance requirements
  • The higher tax rate will be applied to their 2019 earnings robbing them of the opportunity to plan without any fault of their own.

The figure below provides a glimpse into how the tax numbers are going to change drastically if this new regulation is ultimately implemented:

In light of this situation, the Association of Labuan Trust Companies have appealed against the implementation of this revised tax regulation, but as of now it is unknown what the government is going to decide. So, we can only wait and watch.

But if this change is ultimately implemented, the Labuan jurisdiction will lose its best feature for all international entrepreneurs and digital nomads.

On a Final Note…

So, what are the options for the international businesses looking to incorporate a mid-shore company with a more favourable tax rate?

It is advisable to relocate and incorporate your business in the most suitable jurisdiction with the best option in terms of lower tax rates, ease of doing business, the currency for transactions, banking options, etc.

According to a recent survey, the best countries currently to incorporate a remote based company are Singapore, Malta, Andorra, Cyprus, Hong Kong, Estonia among few others.

Each of these jurisdictions will have its own laws, tax requirements, wealth building and management, regulatory compliances, etc. Hence it is absolutely vital to rely on experts who can handle this and educate you on how to go about it. They can find the best option for you which grants you the lowest tax rates and a more stable and trustworthy business environment so that you can maximise your income without any added complexities to your business.

Talk to an Expert!

At LinkFacility, our team of experts can assist you with tailor-made end to end solutions for incorporating your business.

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Guidelines and legislation

Please click on the following links for further reading on this subject:

https://www.labuanibfc.com/clients/Labuan_IBFC_78C2FF81-703A-4CAA-8926-A348A3C91057/contentms/img/Downloads/guideline/general/2019/Circular%20on%20LIC%20Pronouncement%201-2019_19062019.pdf

https://www.labuanibfc.com/clients/Labuan_IBFC_78C2FF81-703A-4CAA-8926-A348A3C91057/contentms/img/Downloads/guideline/general/2019/Circular%20on%20LIC%20Pronouncement%202-2019_12122019.pdf

https://www.labuanibfc.com/clients/Labuan_IBFC_78C2FF81-703A-4CAA-8926-A348A3C91057/contentms/img/Downloads/legislation/principal-legislation/2019/Labuan%20Business%20Activity%20Tax%20Act%201990_(Updated%202018)_17062019.pdf?1578631459