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Lowtax International Tax Planning/IOFC Analysis - Labuan

By Lowtax Editorial
08 November, 2011

In an increasingly competitive and globalized world, international offshore financial centres rarely stop evolving and adapting to new circumstances and economic realities, and perhaps one of the most innovative, but lesser known, jurisdictions of recent times has been the Malaysian island of Labuan, which continues to go from strength to strength, despite the testing global economic conditions.

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 it is already attracting significant interest from businesses in the major emerging economies in the region.

Whilst Labuan has been ostensibly an offshore centre since 1990, it has only been in the last ten years or so that there has really been significant growth in the number of offshore firms registered in the jurisdiction. The year 2002 was particularly significant. After conducting some well-targeted roadshows in Hong Kong, mainland China and other regional business hubs, company registrations grew by 30%. It was also a year in which the Labuan International Financial Exchange (LFX) emerged as a regional force and Labuan began to be talked about as a major global Islamic Finance centre.

In 2010, the Labuan IBFC maintained positive growth across all key business sectors, but particularly banking, leasing and insurance, despite the more challenging global environment, and new measures have been implemented recently to improve the flexibility and business-friendliness of its tax and legal framework, becoming effective in 2009 and beyond.

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 re-branded itself as Labuan FSA (Labuan Financial Services Authority), and the centre itself as IBFC (Labuan International Business and Finance Centre).

According to the Labuan FSA's 2011 Annual Report, in 2010, the number of Labuan companies registered under the Labuan Companies Act 1990 recorded growth of 7.8%, increasing to 8,004, compared to 7,423 companies in 2009. These originate from close to 100 countries, of which about 60% are from the Asia Pacific region, mainly for investment holding purposes, although Labuan is also used for Special Purpose Vehicles, international financial activities and trading.

Of note in 2010 were the new laws which have substantially improved the regulation and development of Labuan’s international financial markets. An additional clause to the Labuan Offshore Business Activity Tax Act, which is now known as the Labuan Business Activity Tax Act, has enabled the adoption of the Organization for Economic Cooperation and Development standard for the exchange of information for tax purposes in double taxation agreements.

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.

With effect from June 1, 2009, Labuan holding companies have been accorded the extra flexibility to have a physical presence in Kuala Lumpur. Similarly, Labuan banking institutions and insurance companies that meet the predetermined criteria have also been allowed to have a physical presence onshore from 2010 and 2011, respectively.

For income tax purposes, Labuan is considered part of Malaysia and therefore Malaysian tax rules apply to individuals working in Labuan, although there are many exemptions available to individuals and companies.

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 M$20,000 for that year of assessment.

An offshore company which carries on an offshore non-trading activity is exempt from income tax altogether.

The Income Tax Act 1967 applies to any activity other than offshore business activity carried on by an offshore company, ie they pay normal taxes.

Individuals and corporate entities doing business in Labuan are additionally entitled to a number of tax privileges and deductions as a result of the offshore regime.

Malaysia’s network of double taxation agreements, which comprises more than 60 countries, can also be used by Labuan companies. All Malaysian tax treaties follow the OECD model treaty with some modifications and most have low rates of withholding tax on outgoing payments. However, although Labuan, as an integral part of the state of Malaysia, gains the benefit of the country's tax treaties, which were largely signed before Labuan's offshore regime came into existence, some countries have specific or general anti-avoidance legislation which excludes Labuan offshore entities from treaty benefits. But Asian countries on the whole tend to have accepted Labuan in treaty-based tax planning, largely no doubt because they are all themselves hungry for inward investment.

Leasing out of the Labuan International Business and Financial Centre IBFC has become a particularly successful business sector for the jurisdiction. In 2010, the number of leasing companies increased by 29.4% while the amount of assets leased grew by 14.2% to USD25bn compared to USD21.9bn in 2009. The leasing sector was primarily driven by leasing transactions in the oil and gas, shipping, aviation and telecommunication sectors.

More recently, a range of incentives were announced to attract oil and gas traders to Malaysia. The new scheme will be operated by the newly-formed Labuan International Trading Commodity Company (LITC) out of the Labuan IBFC, and is intended to diversify further the products and services of Malaysia’s financial services sector.

Last month, at the launch of the Global Incentives for Trading (GIFT) programme and the newly-formed LITC, the Director-General of Labuan Financial Services Authority (FSA) Encik Ahmad Hizzad Baharuddin said that, over the years, the oil, gas and energy sector has contributed significantly to the growth of the country and now accounts for about 20% of Malaysia’s gross national product. The government has earmarked the sector as one of the country’s key economic growth areas.

In addition, he pointed out that: “While Malaysia has thriving up-stream activities in the oil and gas sector, more activities could be initiated at the various levels in the business value chain, particularly in the trading of petroleum and its related products. This offers a huge potential for Malaysia to tap into the oil trading market, as it would not only generate revenue for the country, but would also increase the pool of expertise and talent, and improve the transfer of technology.”

At this initial stage, one of the main objectives of the GIFT programme, Ahmad Hizzad disclosed, is to attract major international oil trading companies, such that they would consider locating part of their operations in Malaysia. In attracting these international companies, the programme offers a set of incentives through the establishment of the LITC.

LITCs under the GIFT programme are also entitled to pay corporate tax at a rate of 3% of chargeable income, and they benefit from 100% exemption on directors fees paid to non-Malaysian directors, and a 50% exemption on gross employment income for non-Malaysian professional traders and managers of LITC companies. There is also an exemption from stamp duties on documentation for such business activities, a tax exemption on dividends received by or paid from LITC companies, and all of the other fiscal incentives that are attached to operating a Labuan entity.

Ahmad Hizzad emphasized that the attractiveness of using the Labuan IBFC as a base for oil trading business in Malaysia extends beyond fiscal incentives. The IBFC plays host to over 400 international financial institutions comprising 61 banks, 169 insurance and insurance-related companies, 176 leasing companies, amongst others, and is considered an ideal location as it provides the oil and gas trading companies with a comprehensive range of financial products and services, both under conventional and Shariah-based principles.

The Labuan FSA has noted that the banks and insurance companies in Malaysia, including Labuan, are already gearing up towards providing the specialized financial services in their oil trading desks that will needed by the trading companies.

Earlier in October, IBFC Chief Executive Officer David Kinloch said that the attractions of Labuan as a base for captive insurance companies are increasingly being recognized, and the sector is expected to expand significantly next year.

There are 34 captive companies established within the IBFC, of which 14 are Malaysian companies. The sector had total assets of over US33bn in 2010, with total gross premiums of US1.2bn.

However, Kinloch has pointed out that, while there is a large untapped market in Malaysian companies that have significant insurance needs, Labuan is also now attracting European and Asian multinational companies away from other captive insurance destinations in the region, such as Singapore.

As the IBFC has been operating captive insurance only for some five years, and the period for developing such products, and for companies to take decisions, is substantial, Kinloch disclosed that he expects the recent emphasis put into the sector by Labuan to mean that there will be a substantial influx of captive insurance business in 2012.

The insurance sector in general continues to expand in Labuan, and last year 22 new licences were approved, comprising nine insurance brokers, seven underwriting managers, three reinsurers, two captive insurers and one general insurer. The gross premium of the insurance sector surpassed the USD1.0bn mark for the third consecutive year. Captive insurance saw premiums increase by 47% to USD186.9m in 2008.

Whilst Labuan has succeeded in attracting conventional business interest from all over the globe, its most exciting potential area of future growth is in catering for the growing demand for Islamic finance products. The Islamic banking sector, comprising six Islamic banks and nine banks with Islamic windows, saw total deposits grow 63.6% to reach USD1.3bn in 2010 as compared to USD794.7 million in 2009, representing 3.8% of the total assets of the Islamic banking industry. It is believed that as of 2011, global Islamic assets are worth in the region of USD1 trillion, the industry having grown at an annual rate of about 20% in recent years.

So from relatively humble beginnings, Labuan can now be said to be an IOFC to be reckoned with, having built up a favourable reputation with international investors in a short space of time. However, the authorities do not intend to rest on their laurels, and the Labuan FSA's 2011 Annual Report revealed that several key strategies have been identified to advance Labuan as an international business and financial centre of choice in the region. In the pipeline are a number of initiatives under the Malaysian Financial Sector Blueprint, due to be unveiled by Bank Negara, which aims to provide a holistic approach for the development of the Malaysian financial sector for the next 10 years. Therefore, despite the gloomy world economic outlook and ongoing moves by the OECD to force more regulation on offshore financial centres, with Malaysia’s backing it would seem that the future continues to look bright for Labuan.



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