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Malaysia: Labuan – The hidden card

Money LaunderingMalaysia: Labuan - The hidden card

In brief

The historical fuss about Labuan

With a population of just over 100,000, Labuan is a small Malaysian island located off the coast of Borneo in Southeast Asia. Little known to most is that Labuan, a federal territory of Malaysia, has a special status as an International Business and Financial Centre (IBFC). Prior to its rebranding as an IBFC in 2008, in the 1990s, Labuan was initially declared as an international offshore financial center.

This article appears in the second edition of the Private Wealth Newsletter 2023.

Contents

Route to global compliance

Labuan: a good option?

Conclusion

In 2009, Labuan IBFC was categorized by the Organization for Economic Cooperation and Development (OECD) as a jurisdiction that was “not committed to the internationally agreed tax standard” in its progress report on the implementation of the international tax standard for the exchange of information. Consequently, the Labuan Financial Services Authority, the regulator responsible for the development and administration of Labuan IBFC, reinforced its commitment to the international standard for exchange of information, and to continuous cooperation with other competent tax authorities in curbing tax evasion and financial crimes. The Malaysian government initiated progressive, concrete steps toward ensuring that the legal and tax regimes in Labuan conform to the global shifts on transparency and compliance standards.

As part of the government’s efforts to reposition Labuan as a credible global and business financial hub, the Labuan Companies Act 1990 (LCA) was amended on 9 June 2022 via the Labuan Companies (Amendment) Act 2022 (“Amendment Act“) to introduce various remedial measures.

First, the Amendment Act established a formal beneficial ownership reporting regime for Labuan companies, which is consistent with the framework under the Malaysian Companies Act 2016 (which came into force on 31 January 2017) (MCA). Labuan companies are now legally required to take steps to identify, keep records of and report its beneficial owners. A “beneficial owner” is defined under the LCA to mean:1

– [A] natural person who owns or controls a Labuan company […], in whole or in       part, through direct or indirect ownership or control of shares or voting rights or other ownership interest […], or who exercises effective control and influence […]

This amendment aligns Labuan’s corporate compliance regime with the Financial Action Task Force’s (FATF) recommendations on transparency over company ownership and control, which is evident in the FATF’s recognition of Malaysia as a jurisdiction with robust anti-money laundering policies.

Second, the Amendment Act expressly prohibits the issuance of bearer shares or conversion of shares to bearer shares by Labuan companies. Bearer shares are unregistered shares where ownership is evidenced though the physical possession of the share warrant or certificate. This effectively enabled holders of bearer shares to remain anonymous, and enabled bearer shares to be infinitely transferrable yet untraceable. Due to the confidentiality they offered, bearer shares held a poor reputation for being an easy means of facilitating illegal activities such as tax evasion or money laundering. The prohibition of bearer shares brings the Labuan position on par with the existing Malaysian regime under the MCA, where such shares were already prohibited since 1965.

Third, Labuan companies are now mandated to appoint at least one Malaysia-resident director, which can be fulfilled by either a trust officer of a Labuan trust company, or an individual who is at least 18 years old and a citizen or permanent resident of Malaysia. This amendment effectively requires Labuan companies to have a certain degree of substance in Malaysia.

In terms of the tax regime, notwithstanding that Labuan is territorially part of Malaysia, Labuan entities are subject to a separate tax regime under the Labuan Business Activity Tax Act 1990 (LBATA). Prior to 2019, Labuan entities carrying out specified trading activities could opt to pay tax at a flat rate of MYR 20,000 (approximately USD 4,500) per year regardless of their net profits, instead of 3%. However, in line with Malaysia’s commitment to combat harmful tax practices, Labuan has abolished the flat tax rate and introduced legislation mandating in-scope entities to demonstrate they have sufficient economic substance in Labuan.

Consequently, the new Labuan Business Activity Tax (Requirements for Labuan Business Activity) Regulations 2021 (“2021 Regulations“) require Labuan entities undertaking specific trading activities to comply with the relevant substance requirements to avail of the preferential tax regime under the LBATA. This can be achieved by hiring a minimum number of employees physically located in Labuan, and by incurring a minimum amount of operational expenditure in Labuan yearly, depending on the type and scope of activities carried out by the Labuan entity. If these prescribed minimum requirements are met, the Labuan entity can continue to be taxed at the rate of 3% on its net profits each year as reflected in its audited accounts.

On the other hand, Labuan non-trading entities (such as those carrying out investment holding activities only) may continue to enjoy a 0% tax rate each year under the LBATA if they meet the prescribed substance requirements in Labuan, which are less onerous. For example, a Labuan pure equity holding company is only required to prove that management and control is exercised in Labuan, but it is not required to hire full-time employees in Labuan.

Labuan entities that fail to comply with the prescribed economic substance requirements under the 2021 Regulations will be taxed at a higher rate of 24% on their net audited profits for the particular year, which is the same corporate tax rate applicable to Malaysian companies incorporated under the MCA. Additionally, the tax would be imposed on all accounting profits of the errant Labuan entities, which may include capital gains and dividend income.

Following the legislative amendments discussed above, the Labuan financial services regime has been designated by the OECD’s Forum on Harmful Tax Practices as “not harmful,” indicating that the Labuan tax framework is now compliant with global standards.

Labuan can be an attractive wealth management destination for many reasons, including its physical location. Being strategically located in the center of the Asia Pacific region, Labuan shares the same time zone with key Asian cities and financial hubs such as Singapore and Hong Kong.

Moreover, Labuan remains a tax-efficient jurisdiction. Other than the competitive tax rates outlined above, where the prescribed substance requirements are met, Labuan entities currently have access to the benefits under most of Malaysia’s extensive network of double tax treaties. Individuals and families setting up cross-border wealth-planning structures in Labuan may also benefit from the tax exemptions available to non- residents for withholding tax on dividends, interest and other payments from Labuan entities. Notably, stamp duty is also exempt on all instruments executed by a Labuan entity in connection with a Labuan business activity, on constituent documents and on transfer of shares in a Labuan company.

In addition, Labuan provides high-net-worth individuals and families with many wealth management and succession planning tools and vehicles. For example, Labuan is the first common law jurisdiction in Asia to offer the civil law concept of a private foundation. Foundations, being self-owned corporate bodies with separate legal personalities, can be a suitable option to hold assets for charitable and non-charitable purposes.

At the same time, Labuan has adopted modern trust legislation, which enables families to establish trusts that can accommodate the succession planning needs and preferences of present-day settlers. This includes the setting up of purpose trusts, reserved powers trusts and trusts with no perpetuity period – all of which are not viable under the common law trust concepts that Malaysia adopts. There is also an option for those seeking Shariah-compliant solutions to set up Islamic trusts and foundations.

Furthermore, Malaysia continues to maintain liberalized foreign exchange control rules, which are issued by the Central Bank of Malaysia pursuant to the Financial Services Act 2013. These rules prescribe some limits in relation to dealings between (and among) Malaysian residents and non-residents, in Malaysian ringgit and foreign currency. Although Labuan is geographically considered part of Malaysia, Labuan entities are regarded as non-residents for the purposes of the Malaysian foreign exchange control regime, and may freely transact with other non-resident entities without limits.

Labuan IBFC has been promoted as an international business and financial center and, from a tax and legal perspective, has positioned itself as a jurisdiction worthy of consideration for various wealth and succession planning initiatives. Armed with an informed understanding of the revamped legal and tax regime, Labuan could be an ideal jurisdiction for certain private clients and their advisers wishing to set up wealth management structures in the Asia Pacific region.

1 Section 108A of the LCA.

Story from www.globalcompliancenews.com

Disclaimer: The views expressed in this article are independent views solely of the author(s) expressed in their private capacity.

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