Labuan offshore tax and legal regimes

In April 2009, Malaysia (Labuan) was added to the Organization of Economic Cooperation and Development's new 'blacklist' of jurisdictions which had not committed to implementing the internationally agreed standard in tax transparency.

The list, was published on April 2, following the G20 London Summit and was issued at the same time as a communique by government leaders which set out the major economies' vision of the future global regulatory and economic landscape. "We stand ready to deploy sanctions to protect our public finances and financial systems," read the communique, presented by British Prime Minister Gordon Brown, which went on to declare that: "The era of banking secrecy is over."

In response to the 'blacklisting' Malaysia said it was committed to internationally-agreed tax standards and should not be categorized with jurisdictions that have not.

The Prime Minister Datuk Seri Najib Tun Razak explained on April 2, 2009, that Malaysia had sent a statement to the OECD leaders to reaffirm its commitment to subscribe to the OECD standard for the effective exchange of information (EOI).

Najib, who is also Finance Minister, was responding to reports that Malaysia and its offshore jurisdiction, Labuan International Business and Financial Centre (IBFC), has been categorized as “jurisdictions which have not committed to the internationally-agreed tax standards.”

“We should not be in that category as – in practice – we have been committed to OECD requirements. Our statement to OECD leaders earlier this week was to re-affirm this," he remarked, adding:

“I understand that the list is a progress report or status report of jurisdictions which have not committed to the internationally-agreed tax standards.”

Najib also clarified that Labuan has never been in any list of “tax havens” issued by OECD and Malaysia has always been cooperative with competent authorities:

“At all times, Labuan IBFC, LOFSA and Malaysian authorities have been co-operative with competent authorities from other countries on tax matters and financial crime, particularly money laundering."

“Our commitment is further evident from the on-going efforts to tighten provisions of EOI which are already in keeping with OECD requirements,” Najib continued, going on to state:

“Certainly, we expect the OECD to amend the list to put us in the category of jurisdictions that have committed to the internationally agreed tax standard."

In a statement, Labuan Offshore Financial Services Authority (LOFSA) welcomed the approach by the G20 and OECD to take measures to stamp out tax evasion. LOFSA said since its inception, the jurisdiction has met the highest international standards and has received positive assessments by the International Monetary Fund (IMF) under its Offshore Financial Sector Assessment Programme.

In addition, Labuan IBFC has been affirmed as a “low-risk” jurisdiction for money laundering by the Asia Pacific Group on Money Laundering which is a division of the Financial Action Task Force and an associate body of OECD.

LOFSA said existing EOI provisions have already met OECD requirements. Efforts are also taken to tighten them further through the legislative process. Malaysia, as the world’s 19th largest trading nation, has double-taxation agreements with 69 countries.

These agreements have specific terms on the EOI which were in fact drafted by OECD. These terms commit Malaysia to cooperate with regulators to eradicate tax evasion.

Malaysia has since been elevated to the OECD's 'white list' of countries which have "substantially implemented" the internationally agreed tax standard.

In February 2010, new laws which, it is hoped, will substantially improve Labuan’s competitive edge in international financial markets came into effect.

A total of four new acts, together with radical amendments to a further four existing laws, will completely change the way in which Labuan carries on its financial services business. With the enactment of the new laws, the Labuan Offshore Financial Services Authority will be re-named the Labuan Financial Services Authority (Labuan FSA).

Dato Azizan Abdul Rahman, the Director-General of Labuan FSA said: “These far-reaching changes cover all financial activities in Labuan International Business and Financial Centre – from banking, insurance, leasing and company incorporation right through to the creation of Islamic financial products and services. Apart from that, the changes have taken into consideration all aspects so that we are ahead of accepted international standards and practices.”

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.

Labuan Forms of Offshore Operation

Offshore operations may take place within the following forms:

Click on any of the forms for a description of its legal basis. The annual fee for an offshore company is RM1,500, while for a foreign offshore company the fee is RM5,300.

Labuan Tax Treatment of Offshore Operations

See Domestic Corporate Taxes for the general principles of Malaysian corporate taxation, which also apply to offshore entities when they pay tax.

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.

The following income is traditionally exempt from tax in the hands of a Malaysian or foreign recipient:

a dividend received by, or received from an offshore company;
distributions received from an offshore trust by the beneficiaries;
royalties received by a non-resident or another offshore company;
interest received from, or by, an offshore company under certain circumstances and amounts received from an offshore company for providing services.

No withholding tax is applicable to items of income specifically exempt from tax.

Stamp duty for the transfer of shares and preparation and filing of Memorandum and Articles of Association by an offshore company has been waived.

A number of other tax privileges were available at the time of writing:

65% of income from offshore entities from the rendering of legal, accounting, financial or secretarial services, including that of a trust company as defined in the Labuan Trust Companies Act, 1990 is exempted from tax.
Income earned from renting a "qualifying asset" to an offshore company in Labuan is exempt from tax for an amount of up to 50% of the income received for a period of 5 years. Thus a developer can expect to only pay tax on 50% of the income received from a building rented out to offshore companies.
50% of the housing and regional allowances given to residents working in the public sector and offshore companies in Labuan are exempted from tax.
Second tier dividends declared out of dividends received from an offshore company by a domestic company are exempted from tax.
Distributions made by an offshore trust are not subject to income tax in the hands of the beneficiary.
Royalties paid by an offshore company to a non-resident person or another offshore company are not subject to income tax and hence are not subject to withholding tax.
Interest paid by an offshore company to a nonresident person or another offshore company is not subject to income tax. However, where the interest accrues to a banking, finance company or insurance business carried on by the nonresident person in Malaysia, that interest will be subject to income tax as part of business income.
Interest paid by an offshore company to a resident person, other than a person carrying on a banking, finance company or insurance business in Malaysia, is not subject to income tax.
Technical or management fees paid by an offshore company to a nonresident or another offshore company is not subject to income tax.

Speaking at the release of the Labuan Offshore Financial Services Authority (Lofsa) annual report for 2006, Tan Sri Dr Zeti Ahktar Aziz, Bank Negara Governor and Lofsa chairman, said that new tax initiatives would be included in the 2008 budget, due to be announced in September 2007, along with new company forms to better cater for the requirements of offshore investors.

"With the new incentives, LOFSA will be able to compete with other offshore centres in the Asia-Pacific region and the world," Zeti told reporters.

“We want to be competitive and relative to other offshores as the environment is changing very significantly," she added.

Prime Minister Abdullah Ahmad Badawi stated in his 2008 budget speech that in future, companies registering in the Labuan offshore sector would have the option of having their offshore business income taxed under the Income Tax Act 1967, in addition to under the Labuan Offshore Business Activity Tax Act 1990.

"In the light of greater global competition, we need to ensure that Labuan remains competitive as an international offshore financial centre. Given that investors in Labuan undertake a wide range of financial services, a flexible tax regime is necessary," the Prime Minister explained.

Malaysia Tax-Efficient Structures

Malaysian External Investment

"The Malaysian Satay" was the name given to a corporate structure which has traditionally involved the ownership of a foreign subsidiary by a resident Malaysian holding company which is in turn 100% wholly owned by an offshore Labuan parent corporation. In this structure, reduced rates of foreign withholding tax obtainable through double tax treaties (Malaysia has more than 60, although not all are in force) are not compromised by the offshore status of Labuan; yet the income once in the hands of the Malaysian parent can be passed on without further tax to the Labuan holding company.

If the foreign subsidiary were owned directly by a resident Malaysian company with no offshore Labuan connection then domestic Malaysian taxes will have to be paid; if the foreign subsidiary were owned directly by a Labuan holding company, no Malaysian taxes will be paid, but an increasing number of treaty partners are denying treaty benefits to Labuan companies.

Foreign Direct Investment in Malaysia and Korea

Whilst foreign corporations traditionally require government permission if they are to own shares in a Malaysian company this requirement has usually been waived where the Malaysian company is to be 100% owned by a Labuan company which is in turn 100% owned by foreigners. Foreign ownership rules had previously deterred foreign companies from owning Malaysian corporations.

Dividends and other income earned by foreign investors in Malaysia can usually be extracted through Labuan without taxation.

The interposition of a Labuan company by investors into Korea and other regional target markets has benefits because income can be routed through Malaysia or Labuan in order to take advantage of double taxation treaties and the absence of taxation between Malaysia and Labuan. This route has been much used by investors into Korea: it is said that more than a third of Labuan companies are used as holding companies for Western investment into Korea.

A Labuan company selling in China may take advantage of the treaty between Malaysia and the PLC so as to avoid the representative office in the PLC being regarded as a PE.

Labuan Offshore Tax Treatment Of Foreign Employees

A non-Malaysian citizen employed in Labuan in a managerial capacity would have been exempt from payment of tax on up to 50% of his employment income until 2004; this concession has been extended a number of times, so it is worth checking the current tax status of overseas employees before the decision on whether to live and work in Labuan is made.

Labuan Offshore Activities

An Offshore Company (or an Offshore Foreign Company) is only permitted to carry on business in, from or through Labuan. An Offshore Company may not:

carry on business with a resident of Malaysia except as permitted by the Offshore Banking Act 1990;
carry on the business of Banking or Insurance or such similar business unless it is licensed so to do under the Offshore Banking Act 1990 or the Offshore Insurance Act 1990;
carry on business in the Malaysian currency except for defraying its administrative and statutory expenses;
carry on business of shipping or petroleum operations in Malaysia or carry on business as a trust company.

The Offshore Companies Act was amended to allow Malaysians to own offshore companies, as well as to permit foreign-owned offshore companies to invest in Malaysia subject to certain conditions.

Manufacturing activities are normally carried out by companies incorporated under the Malaysian Companies Act. An activity which is neither offshore trading nor offshore non-trading will be subject to tax under the regular tax regime.

Offshore insurance and banking businesses are permitted to maintain a marketing office in Kuala Lumpur until the Government decides that the management office should be relocated in Labuan.

An Offshore Company is not treated as carrying on business with residents of Malaysia if:

it makes or maintains deposits with a person carrying on business in Malaysia;
it makes contact with professional advisers carrying on business in Malaysia;
it prepares and maintains books and records in Malaysia; it acquires or holds any lease or property for operational purposes or accommodation of its employees;
it holds directors’ or members’ meetings within Malaysia;
it holds shares, debt obligations, or other securities in a company incorporated under the Offshore Companies Act 1990 or in a domestic company, or holds shares, debts obligations or other securities for the purposes of a transaction entered into in the ordinary course of a money-lending business.

Labuan Employment and Residence

To facilitate offshore activities in Labuan, a liberal immigration policy has been adopted. Multiple entry visas are issued to expatriates who have been granted employment permits to work with offshore companies in Labuan.

The normal Malaysian rules, which are softened in many situations in Labuan, are as follows:

Any person who wishes to enter Malaysia to take up employment with a Malaysian company or firm must apply for an employment pass from the Department of Immigration.

Employment passes are issued for a specified period, usually two to three years, and are renewable for an additional two to three years.

Employment passes are granted on a case-by-case basis, generally for positions that require special technical knowledge or expertise not available locally or for positions that cannot be filled by local Malaysian citizens.

To obtain employment passes, expatriates must have a valid passport from their home country, a contract from their employer, a cover letter and three passport-size photos, which may be black and white or color.

The employer of an expatriate must submit an application to the Department of Immigration and await a decision, which may take one month. After the employer receives a letter of approval, it must submit the passport of the employee and pay for the employment pass and the levy. The levy is applicable only to expatriates earning less than a designated amount per month or to expatriates holding employment passes valid for less than two years.

Licensed manufacturing companies that wish to hire expatriates must present copies of their manufacturing licenses. Service companies with foreign equity of more than 30% must seek the approval of the Foreign Investment Committee before hiring expatriates. Companies engaged in construction and project management must register with the Construction Industry Development Board before hiring expatriates. Companies engaged in the retail, trade, wholesale and direct-sales sectors that have foreign equity of more than 30% must seek the approval of the Committee on Wholesale and Retail Trade before hiring expatriates.

It is illegal to work without a valid employment pass; therefore, a foreign national may not work in Malaysia until he or she has received a work permit and all other necessary documents.

To obtain an extension, expatriates must submit new applications for extension three months before the expiration of their passes.

Expatriates who have not completed their terms of contract but wish to take up employment with other companies must leave the country for six months before taking up new employment.

In 2003, the Malaysian government decided to make it easier for companies to hire skilled foreigners, allowing for automatic approvals to be granted for the recruitment of highly skilled workers where there is no available local expertise.

From June 2003, the government further relaxed rules on employing expatriates, granting that manufacturing companies with foreign paid-up capital of at least US$2m be automatically permitted ten expatriate positions, with those to include five key posts. Under the amended rules, expatriates could be employed for up to ten years for executive posts and five years for non-executive posts.

Manufacturing companies with foreign paid-up capital of US$200,000–2m, meanwhile, were permitted automatic approval for up to five expatriate posts, including at least one key post.