IOFC Analysis - Labuan
By Lowtax Editorial
30 December, 2013
Labuan, situated a few miles off the northern coast of Borneo in Malaysia and just 60-odd square miles in size, is one of the newer additions to the list of the worlds offshore jurisdictions. But the jurisdiction has quickly risen to prominence as one of the preferred platforms for investment into the regions emerging economies.
Situated in the heart of the fast growing South Eastern Asian region, and close to a number of major cities and economic hubs such as Singapore, Hong Kong, Kuala Lumpur and Jakarta, Labuan is currently home to a population of around 85,000, benefits from a benign income tax regime, a well regulated financial regime, a deep water port and a well-developed supporting infrastructure, including internet communications.
Used by the British as a coaling station in the days of empire, Labuans economic existence has traditionally depended on its port and position at the confluence of Eastern Asians trade routes. Latterly, oil and gas exploration and their supporting industries were the main contributors to the islands economy. However, these are fast being superseded by financial services, and tourism is also a growing industry as the islands year-round tropical climate, coral reefs and sandy beaches become more well-known.
Given the jurisdictions current growth trajectory, it could well soon be giving other more established financial jurisdictions a run for their money, particularly in the field of Islamic finance.
The Labuan International Business and Finance Centre (IBFC)
The financial services industry in Labuan has taken root thanks to the creation of the Labuan International Offshore Financial Centre in 1990, along with the passing of a batch of offshore laws and the creation of LOFSA (Labuan Offshore Financial Services Authority). With the passage of new laws to govern its business environment in 2010, LOFSA has since re-branded itself as Labuan FSA (Labuan Financial Services Authority), and the centre itself as the IBFC (Labuan International Business and Finance Centre).
Despite the challenging global economic environment, the Labuan IBFC has recorded healthy growth over the past few years, and the island has quickly grown as a major conduit for Foreign Direct Investment into a number of local countries, particularly South Korea and Malaysia itself.
Releasing its 2012 Annual Report in June, 2013, the Labuan FSA said that 2012 saw a continuation in growth trajectory across the key business sectors in the IBFC, including the banking, insurance and reinsurance, and leasing sectors. Its achievements last year were mainly attributed to its strategic focus towards the emerging economies, particularly in Asia.
The IBFC is now home to 59 banks, 203 insurance and insurance-related companies, 257 leasing companies and 37 trust companies. Of notable achievement, it was said, has been the expansion of Labuan foundations, the number of which increased by 62.5 percent, to 65 foundations from 40 the year before.
In October 2013, the Labuan FSA announced that the Labuan IBFC achieved a major milestone by surpassing the 10,000 companies mark during the third quarter of this year.
As of August 31, 2103, a total of 10,003 companies had a presence in Labuan IBFC comprising 641 licensed entities and 9,362 normal Labuan companies, of which 4,660 are operating.
More than 70 percent of the Labuan companies originated from the Asian region. This reflects Labuan IBFC's aim to foster regional financial integration in facilitating cross-border trade and investment in the regional emerging market. Nonetheless, the jurisdiction has also witnessed sustainable interest from investors in Europe and America, as well as the Middle Eastern region.
Indeed, the Labuan companies registered in Labuan IBFC originated from more than 100 countries. In terms of segregation by region, 57.7% (2011: 58.0%) of Labuan companies originated from the Asia and Pacific region, largely from Malaysia, Indonesia, Singapore, Australia and Thailand. This was followed by Europe with 13.3% (2011: 13.6%) with companies mainly from United Kingdom, Switzerland, Ireland, Netherlands and Germany. The Far East region contributed 13.0% (2011: 13.9%), the Americas 9.7% (2011: 10.2%), while the Middle East and Africa have the remaining 6.3% (2011: 4.2%).
Another milestone was achieved during the year with the acceptance of the IBFC as a recognized jurisdiction by the Stock Exchange of Hong Kong for Labuan-incorporated companies to obtain listing in Hong Kong.
The Offshore Companies Act 1990 provides for the establishment of offshore companies and the registration of foreign offshore companies in Labuan. In addition, a foreign company incorporated under the laws of another country may apply to be registered as being continued in Labuan. Every offshore company may be a company limited by shares or by guarantee. The abovementioned companies may participate in offshore activities and enjoy the attractive tax treatment provided under the Labuan Offshore Business Activity Tax Act 1990 (see below).
Residents and non-residents of Malaysia are permitted to establish offshore companies in Labuan. An offshore company may carry out any business that is lawful in Malaysia in, from or through Labuan, but banking, insurance and insurance-related businesses, fund management, leasing, factoring and company management would require the offshore company to be licensed. Shipping operations in Malaysia are prohibited.
The Offshore Companies Act was amended recently to allow Malaysians to own offshore companies, as well as to permit foreign-owned offshore companies to invest in Malaysia subject to certain conditions.
New laws which, it is hoped, will substantially improve Labuans competitive edge in international financial markets came into effect in February 2010. The new laws allow for the creation of Labuan foundations, limited liability partnerships, protected cell companies (insurance and mutual funds), shipping operations, Labuan special trusts and financial planning activities. These complement the existing available range of products and services and aim to provide investors with a wider choice of financial products to maximise investment opportunities.
Regular Malaysian companies can be used in Labuan, but will not receive the tax and other privileges accorded to Offshore Companies.
Generally, companies incorporated in Malaysia are regulated by the Malaysian Companies Act, 1965. The types of companies are:
- a company limited by shares, which can be private or public;
- branch of a foreign company;
- partnership or sole proprietorship.
Foreign investors normally conduct their businesses in Malaysia in the form of a private company limited by shares.
In line with the Malaysian government's move to liberalize the financial sector, Labuan Holding companies have been permitted to set up an operational and management office in the capital city of Kuala Lumpur since 2009.
Offshore Financial Sectors
Labuan banks are in the business of providing credit facilities, receiving deposits, investment banking services, building credit and credit token business, development finance business, leasing business, factoring, money broking, Islamic banking business, or such other activities as are approved by the Minister of Finance, Malaysia. All Labuan banks are governed and regulated under the Labuan Financial Services and Securities Act 2010.
The Labuan banking sector remained sound and stable in 2012 with a strong capital position amid continuing improvements to its operational and risk management practices. The ratio of gross non-performing loans of Labuan banks improved to 1.3% from 1.5% in the previous year, while the industrys average risk-weighted capital ratio and core capital ratio stood at 20.6% and 20.5% respectively.
Overall, the banking sectors asset base grew to USD42.1 billion from USD38.3 billion in 2011 and correspondingly its loans and advances continued to expand during the year, with non-residents holding the majority of 60.6% of the total loans outstanding. This is in line with the centers aspirations to serve out-out business. The Labuan banking sector also recorded a significant increase of 41.2% in its pre-tax profit for the year.
Labuan insurance business includes life, general, reinsurance, captive insurance, insurance management, underwriting management and insurance broking, but does not include domestic insurance business; and it is transacted in foreign currency. Labuan insurers may carry on reinsurance of domestic insurance business in Malaysian currency and such other business as may be specified by the Labuan FSA.
Labuan insurance activities are governed by the Labuan Financial Services and Securities Act 2010.
Effective March 2011, Labuan insurance and takaful entities, with the exception of insurance management and underwriting, may co-locate their offices in any parts of Malaysia.
Some of the highest rates of growth in the Labuan IBFC were recorded in the insurance sector in 2012. A total of 29 new licences were issued comprising a majority of insurance brokers and captive insurers. Total assets for Labuan insurance entities jumped 16.0% to USD4.2 billion and total gross premiums grew to USD1.7 billion, with non-resident business constituting the higher share of 53.9%. In terms of distribution of gross premiums, the fire sector continued to dominate the market share followed by the engineering and marine sectors.
The year also saw two large reinsurance companies relocate their branches from Europe to Labuan IBFC to focus their businesses on the Asia and Oceania region.
The Labuan IBFC is also positioned to capitalise on the growth of the oil and gas industry in Asia, and is fast becoming the financing hub for the regions oil and gas business. Accordingly, the Labuan leasing business was the best performing sector for the year, with 41 new leasing companies approved. The continued rising demand for leasing facilities particularly in the oil and gas industry and the aviation sector has contributed to the expansion in the sectors cumulative assets leased, valued at USD32.4 billion as compared to USD27.6 billion in 2011.
Trusts and Wealth Management
Labuan IBFC offers a comprehensive array of wealth management products suitable for high net-worth individuals, family offices and other wealth managers needing structures for efficient wealth transfer and inheritance management.
The relevant Acts related to wealth management include the Labuan Trusts Act 1996 and the Labuan Foundations Act 2010 that permit the establishment of a wide diversity of structures such as trusts and foundations for the management of international and approved Malaysian assets.
The presence of international trust companies in Labuan IBFC has established a greater cross-border network to provide the range of services, including shared services to meet the demands of sophisticated clients worldwide. During the year under review, Labuan trust companies continued to display a steady growth momentum with five new companies established.
Labuan foundations are another area of growth for the Labuan IBFC. For the year 2012, a total of 25 new Labuan foundations were registered in Labuan IBFC, bringing the total number to 65, an increase of 62.5%. The composition of Labuan foundations consisted of 59 conventional and six Islamic. The Labuan foundations originated mainly from the Asia and the Pacific region with 63.1% (2011: 57.5%), Middle East and Africa 20.0% (2011: 25.0%), Europe 9.0% (2011: 12.5%), America 5.0% (2011: 0) and the Far East with 3.0% (2011: 5.0%).
The Labuan IBFC is being positioned as the leading centre for Islamic finance and wealth management in the Asia Pacific region.
Labuan's situation is helped a great deal by the fact that it is part of one of the most populous Islamic countries in the world, Malaysia, which is itself attempting to become a hub for Islamic Finance.
The wide range of Islamic financial products and services available in Labuan IBFC includes Islamic banking, Islamic capital markets, takaful, retakaful, Islamic funds, waqf and Islamic trust administration. These products and services are offered under various Shariah-compliant schemes by the Islamic financial institutions in Labuan.
The Labuan Islamic Financial Services and Securities Act 2010 streamline procedures and requirements for all Shariah-related activities in the Labuan IBFC.
The Government of Malaysia provides a number of tax breaks in the area of Islamic Finance, including tax exemptions for foreign Islamic fund managers. In addition, as a result of the Government's 2010 Budget, expenses for the issuance of Islamic securities are also tax deductible.
At the end of 2010, the size of Malaysia's Islamic capital market stood at MYR1.05 trillion, or 52% of the size of the overall Malaysian capital market, as compared to only MYR294bn as at end-2000.
The Malaysian Government hopes that the existence of the Labuan IBFC will act as a catalyst for the growth of Islamic Finance. And in many respects, Labuan is already well on the way to becoming an Islamic Finance hub in its own right.
The Labuan Offshore Business Activity Tax Act 1990 (as amended in 2004) provides for the reduction or complete exemption of income tax in respect of certain business activities carried on by offshore companies in Labuan.
Chargeable profits derived by an offshore company from an offshore trading activity are subject to tax at a rate of 3%.
Alternatively, an offshore company which carries on an offshore trading activity may, within three months from the commencement of any calendar year, elect to be charged to tax of MYR20,000 for that year of assessment.
An offshore company which carries on an offshore non-trading activity is exempt from income tax altogether.
The Malaysian Income Tax Act 1967 applies to any activity other than offshore business activity carried on by an offshore company, i.e. it pays normal taxes.
However, a company registered under the Labuan Companies Act 1990 (and exempt from Malaysian income tax) can make an irrevocable election to be taxed under the Malaysian Income Tax Act. Under this Act, corporations are taxed at 25%, however all foreign-sourced income is exempted from tax. In addition, there is no capital gains tax, except for transactions involving certain landed properties in Malaysia.
This addition to the tax regime, announced in the 2008 Budget, is designed to ensure that Labuan's tax regime remains as flexible as possible, given that investors in Labuan undertake a wide range of financial activities.
A significant advantage of electing to be taxed under the Income Tax Act 1967 is that it provides more certain access to Malaysia's extensive network of double tax avoidance treaties, which includes more than 80 agreements.
Global Incentives For Trading (GIFT) Programme
Under the GIFT program, a general Labuan International Trading Company (LITC) is subject to a corporate tax rate of 3%, but an LITC set up purely as an liquefied natural gas (LNG) trading company is entitled to a 100% income tax exemption on chargeable profit for the first three years of its operation, provided the company is licensed before December 31, 2014.
The LITC is required to maintain a registered office in Labuan, which is the office of its Labuan trust company. However, the LITC is allowed to establish its operational office(s) anywhere in Malaysia, while being required to provide the details of that office to the LFSA upon commencement of business. It must also ensure that its business is conducted with a proper corporate governance and risk management framework in place.
Other tax incentives applicable for an LITC include a 100% exemption on fees paid to non-Malaysian directors of the LITC; a 50% exemption on gross employment income of non-Malaysian professional and managerial staff, including traders with the LITC; an exemption on dividends received by or from the LITC; an exemption on royalties received from the LITC; an exemption on interest received by residents or non-residents from the LITC; and a stamp duty exemption on all instruments for Labuan business activities and the transfer of shares.
In January 2013, the Labuan FSA issued guidelines applicable to all Labuan international trading companies (LITCs) licensed to conduct international commodity trading business in the Labuan IBFC under the GIFT programme.
The guidelines, which went into effect on January 1, 2013, and supersede those previously issued on October 31, 2011, cover a Labuan international commodity trading business involved in the trading of physical and related derivative instruments of petroleum and petroleum-related products including liquefied natural gas (LNG), agriculture products, refined raw materials, chemicals and base minerals. An LITC can deal only with non-residents in any currency other than Malaysian ringgit.
In addition, within five years after the date it obtained its license, an LITC must have a minimum annual turnover of USD100m; minimum annual business spending of MYR3m (USD995,000) payable to Malaysian residents; and at least three professional Malaysian-resident traders employed with a minimum salary of MYR15,000 per month each.
In September 2013, the Labuan FSA confirmed that it remains committed to upholding its legal framework in line with internationally-agreed tax standards and best practices, following a meeting with the Organization for Economic Cooperation and Development (OECD) Center for Tax Policy.
"The meeting with OECD is important because it provided a stakeholder engagement platform for the Labuan Financial Services Authority (Labuan FSA) to reiterate our position with regards to the regulatory and tax transparency framework, in particular to the effective exchange of information," said Danial Mah Abdullah, Deputy Director General of Labuan FSA. "The OECD Center's continued endorsement is important for Labuan IBFC in its ambition to be the International Financial and Business Center for the Asia Pacific."
Labuan is presently on the OECD "white list" of jurisdictions that have substantially implemented internationally agreed tax standards under the Global Forum on Tax Transparency and Exchange of Information and are deemed to have the necessary tax reporting and transparency framework in place.
Initiatives undertaken to further strengthen Labuan IBFC's position in this regard also include Labuan FSA being equipped with adequate powers to ensure Labuan entities comply with statutory requirements, namely record-keeping, accounting, submission of information and powers of entry, search and seizure; and a broadening of the provisions of the Labuan Business Activity Tax Act 1990 relating to the disclosure of information to encompass tax information exchange agreements in addition to the existing double tax agreements signed by Malaysia with more than 74 countries.
Labuan FSA is a member of international organizations, including the International Association of Insurance Supervisors, Group of International Financial Supervisors, and Asia/Pacific Group on Money Laundering, while Labuan IBFC is a full signatory to the International Organization of Securities Commission's Multilateral Memorandum of Understanding Concerning Consultation, Cooperation and the Exchange of Information.
Labuan FSA has also signed the multilateral convention agreement with the European Securities and Markets Authority to strengthen investor protection and cooperation between jurisdictions.
The Labuan FSA does not intend to rest on its laurels. The regulatory authority intends to continue enhancing Labuans legislative framework to be on a par with international standards, as it positions the Labuan IBFC "as a mid-shore jurisdiction with a robust regulatory framework and the flexibility and competitiveness of an international financial center."
The Authority will also continue to pursue greater cross-border supervision cooperation network with other regulators.
"Strategic initiatives going forward would continue to focus on harnessing and improving the financial eco-system of Labuan IBFC to enable different investors to thrive in a conducive and facilitative business environment, without compromising high professionalism and healthy market conduct practices," Director General Ahmad Hizzad Baharuddin explained in the regulators annual report.
Balancing the needs of international investors against demands for ever tighter transparency standards is going to be tricky tight rope to walk. But on the evidence of its results so far, Labuans status as an offshore financial centre of repute looks reasonably secure.
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