Labuan: Asia's Upcoming Mid-Shore Financial Center
By Lowtax Editorial
08 March, 2016
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 world's offshore jurisdictions. But the jurisdiction has quickly risen to prominence as one of the preferred platforms for investment into the region's 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, Labuan's 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 island's economy. However, these are fast being superseded by financial services, and tourism is also a growing industry as the island's year-round tropical climate, coral reefs and sandy beaches become more well-known.
Given the jurisdiction's 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 center 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 2014 Annual Report in June, 2015, the Labuan FSA said that 2014 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 Labuan IBFC is now home to 11,630 companies, 57 international banks, 209 insurance companies, 359 leasing companies, 130 foundations, and nine fund management companies.
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 the Labuan IBFC originate from more than 100 countries, with Western Europe, the Americas and the Middle East and Africa all represented.
Another milestone was achieved in 2012 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 aforementioned 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.
Laws came into effect in February 2010 allowing 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 maximize investment opportunities.
Regular Malaysian companies can be used in Labuan, but will not receive the tax and other privileges accorded to Offshore Companies (see below).
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.
Two new banking licenses were granted by the Labuan FSA in 2014, one to a bank from United Arab Emirates and the other from China. In the same year, Labuan banks' cross-border lending grew to USD32bn, with 76 percent of the total loans and advances contributed by foreign borrowers from ASEAN countries.
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.
In 2014, the regulator approved 18 new insurance and insurance-related licenses with the majority of the licensees originated from Asia. The Labuan insurance sector has a strong margin of solvency of 5.7 times above the minimum regulatory requirement.
The Labuan IBFC is also positioned to capitalize on the growth of the oil and gas industry in Asia, and is fast becoming the financing hub for the region's oil and gas business.
In 2014, Labuan leasing assets increased to USD45.bn with the oil and gas industry accounting for 73 percent of these assets, reflecting Labuan's strategic location as a financing hub for the business.
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's range of wealth management instruments for investment and protection continued to draw interests from regional high net-worth individuals in 2014, with the number of Labuan foundations growing 40 percent that year. Almost three-quarters (73 percent) of the total 130 Labuan foundations originate from Asia.
The Labuan IBFC is being positioned as the leading center 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.
The increasing demand for Islamic finance in Labuan generated the total Islamic financing growth of 28 percent to USD993.3m in 2014, from USD775.6m in the previous year.
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 percent.
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 percent, 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) Scheme
Under the GIFT program, a general Labuan International Trading Company (LITC) is subject to a corporate tax rate of 3 percent, but an LITC set up purely as a liquefied natural gas (LNG) trading company is entitled to a 100 percent 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 percent exemption on fees paid to non-Malaysian directors of the LITC; a 50 percent 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 program.
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 (USD737,000) 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.
The OECD Global Forum has accorded Malaysia (including Labuan IBFC) a rating of "Largely Compliant" under the Global Forum Phase II Peer Review on transparency and exchange of information. This reflects commitment of Labuan FSA towards collaboration in international tax policies and developments
Other initiatives undertaken to ensure that the Labuan IBFC conforms to international standards include equipping the Labuan FSA 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.
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 Labuan's 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."
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, Labuan's status as an offshore financial center of repute looks reasonably secure.
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