This article serves as reference material for candidates preparing for the Paper P6 (MYS), Advanced Taxation.
This article aims to pull together various laws and successive development in the relevant laws relating to Labuan entities to provide an up-to-date picture.
Labuan is an island in the South China Sea off the coast of Sabah in East Malaysia. In 1990, Labuan was established as an international offshore financial centre (IOFC) in a bid to attract international financial activities.
Right from the start, the Malaysian Government had taken pains to avoid the label 'tax haven' for Labuan, and had been vigilant against being used for international money laundering. However, its fixed tax rate of 3% capped at RM20,000 per year clearly calls to mind 'low-tax regime' and inevitably, Labuan was viewed as a tax haven. Some among the double tax treaty partners of Malaysia formally, through protocols or re-negotiated treaties, introduced limitation of benefits (LoB) with regard to Labuan structures.
In response to this development, the Malaysian Government put in laws to facilitate a Labuan entity to irrevocably elect to come under the purview of the mainstream Malaysian tax system rather than enjoy the tax goodies available under the Labuan tax regime.
Consequently, the last few years saw Labuan IOFC being rebranded as IBFC (international business financial centre), involving the renaming Labuan legislations, terms and nomenclatures to omit the word 'offshore' which arguably carries the pejorative 'tax haven' connotations and associations.
Apart from the Labuan Business Activity Tax Act 1990 (LBATA), there are parallel Labuan legislations for Companies Act, Trusts Act. In 2010, a slew of legislations governing foundations, limited liability partnerships, financial services and securities and Islamic financial services and securities have been put in place.
In this article, the focus is on the provisions of the LBATA 1990, as amended.
Salient features and terms used
Labuan means the Federal Territory of Labuan
'Labuan company' means a Labuan company incorporated under the Labuan Companies Act 1990 and include a foreign Labuan company registered under the said Act.
This term includes:
- A Labuan company
- A Labuan foundation
- A Labuan Islamic foundation
- A Labuan Islamic partnership
- A Labuan limited partnership
- A Labuan limited liability partnership
- A Labuan Islamic trust
- A Labuan trust
- A Malaysian Islamic bank licensee
- A Malaysian bank licensee
- Any Labuan financial institutions, as defined
- Any person declared by the Minister to be a Labuan entity under subsection 2B(2).
Preceding year basis of assessment
Tax under the LBATA is levied on the preceding year basis e.g. The year of assessment 2013 has its basis period ending in 2012. This is in contrast to the current year basis practised in the mainstream tax system under the Income Tax Act 1967.
'Labuan business activities'
It means activities carried on by a Labuan entity in a foreign currency with non-residents or with another Labuan entity.
Nevertheless, the Minister of Finance may designate any activity to be a Labuan business activity, which then may enable the carrying out of activities with residents or in the Malaysian currency.
- Shipping operations
- Any other activity not being a Labuan non-trading activity.
Labuan non-trading activities mean activities relating to the holding of investments in securities, stocks, shares, loans, deposits or any other properties by a Labuan entity on its own behalf.
Scope of charge [s3]
A Labuan entity is subject to tax under the LBATA in respect of its Labuan business activity – ie in foreign currency with non-residents or other Labuan entities, or in respect of any designated Labuan business activities which then may be transacted with residents or in the Malaysian currency.
Net profit per audited accounts for Labuan trading activities
Tax is chargeable only on the net profits per audited accounts in respect of Labuan trading activities (– ie banking, insurance, trading, management, licensing, shipping operations and any other activity (other than the holding of investments in securities, stocks, shares, loans, deposits or other properties).
The tax rate is 3% upon the chargeable income from only the Labuan trading activities. This means the income from the Labuan non-trading activities (– ie the holding of investments in securities, stocks, shares, loans, deposits or other properties) of a Labuan entity is not subject to tax at all.
Tax return and statutory declaration
A Labuan entity carrying on Labuan business activities which are Labuan trading activities must file an annual statutory declaration and tax return within three months from the commencement of the year of assessment – ie by 31 March of the following calendar year.
Election for tax of RM20,000
A Labuan entity may elect (within three months of the start of the year of assessment, in a prescribed form) to be charged to tax of RM20,000 instead of the 3% of net profits. This means that the Labuan entity will not be required to submit a tax return for that year of assessment.
In a nutshell, a Labuan entity with an accounting net profit of up toRM666,667 a year should file a tax return and be taxed at 3%. If the income exceeds RM666,667, the Labuan entity should elect to be taxed at the fixed sum of RM20,000 and thereby avoid having to file a tax return as well.
Zakat paid to a Labuan Islamic religious authority (and evidenced by a receipt) up to the amount of tax charged (whether at 3% or at fixed amount of RM20,000) may be given as a rebate. No refund is available if the Zakat paid exceeds the tax charged.
Non-trading activities not chargeable to tax
A Labuan entity carrying on a Labuan business activity which is a Labuan non-trading activity is not chargeable to tax. A statutory declaration in a prescribed form is all that is required compliance-wise.
Election to be subject to provisions of the Income Tax Act
To date, 11 countries have specifically excluded Labuan from treaty benefits in their double tax agreements with Malaysia. They are Japan, Netherlands, United Kingdom, Australia, Sweden, Luxembourg, Republic of Seychelles, Chile, Indonesia, South Africa and South Korea.
In an attempt to facilitate Labuan companies in accessing treaty benefits, the laws have been amended to allow a Labuan company to elect to be treated under the Income Tax Act 1967 rather than the Labuan Business Activities Tax Act 1990.
The election is irrevocable.
No indirect taxes
Labuan enjoys free-port status. Hence indirect taxes are not applicable here.
Stamp duty is exempted on all instruments executed by a Labuan entity in connection with its Labuan business activity.
Labuan entities are also not subject to exchange control restrictions.
Payments by Labuan entities
The following exemptions are available to recipients of income from Labuan entities:
- dividends received by an offshore company
- dividends received from an offshore company which are paid, credited or distributed out of income derived from an offshore business activity or, income exempt from tax
- distributions received from an offshore trust by the beneficiaries
- interest received from an offshore company by a resident person (other than a person licensed to carry on a business under the Banking and Financial Institutions Act 1989, Islamic Banking Act 1983, Insurance Act 1996 or Takaful Act 1984)
In addition, the following payments made by Labuan entities to non-residents are exempted in the hands of the non-resident recipients, and hence are not subject to withholding provisions:
- Technical services, advice or assistance specified in section 4A(i) and (ii) of the Income Tax Act, and
- Other income (see order 209 of 2012 below)
Individuals working in Labuan for Luan entities