Legislation

Guide to Labuan Tax

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By Dickson Loo & Joseph Cheah

Introduction

Unlike a standard ‘Sdn Bhd’ company incorporated under the Companies Act 2016, a Labuan company established within the special economic zone in the Federal Territory of Labuan is afforded a low tax regime. As a company incorporated under the Labuan Companies Act 1990, it is generally only required to pay taxes at a rate of 3%, as compared to the standard rate of 24% for a typical Sdn Bhd. That said, it goes without saying that there are stringent requirements to be complied with prior to the enjoyment of the special tax rate. This article aims to provide a general outlook on the Labuan regime and a summary update on the requirements introduced in:

  1. The Labuan Business Activity Tax (Amendment) Act 2020 (“Amendment Act”) amending the principal Act of Labuan Business Activity Tax Act 1990; and
  2. Labuan Business Activity Tax (Requirements for Labuan Business Activity) Regulations 2018 (as amended by the Labuan Business Activity Tax (Requirements for Labuan Business Activity) 2018 (Amendment) Regulations 2020 (“Regulation”).

 

General snapshot of the Labuan regime

Under the Labuan Business Activity Tax Act 1990 [Act 445] (“LBATA”), a Labuan entity’s scope of business activities is categorized into:

  1. “Labuan non-trading activity” which means an activity relating to the holding of investments in securities, stock, shares, loans, deposits or any other properties situated in Labuan by a Labuan entity on its own behalf; or
  2. “Labuan trading activity” which includes banking, insurance, trading, management, licensing, shipping operations or any other activity which is not a Labuan non-trading activity.

 

Depending on the categorization, different tax treatments will be afforded to the said Labuan entity. In this regard:

  1. Section 4 of the LBATA imposes a tax rate of 3% for a Labuan entity carrying out a Labuan trading activity; and
  2. Section 9 of the LBATA exempts a Labuan entity carrying on a Labuan non-trading activity from paying any taxes under the LBATA.

 

Types of Labuan Business Activities (s.2 of the Labuan Business Activity Tax Act 1990 [Act 445])

 

Applicable Tax rate/treatment

Labuan Trading Activities

3%

Labuan Non-Trading Activities

Not subject to tax

 

Can a Labuan company opt for taxation under the Income Tax Act 1967?

Yes, under section 3A(1) of the LBATA, a Labuan entity can make an irrevocable election to be taxed under the Income Tax Act 1967. However, this option is only normally pursued so as to benefit from the various double taxation agreements signed between Malaysia and other countries which would otherwise be unavailable to a Labuan entity taxed under the Labuan regime.

 

What are the requirements to be satisfied in order to qualify for the Labuan tax regime?

Pursuant to section 2B(1A) of the LBATA, a Labuan entity will have to comply with the following substance requirements:

  1. Have an adequate number of full-time employees in Labuan; and
  2. Have an adequate amount of annual operating expenses in Labuan.

 

Further details on the required number of employees and operating expenses can be obtained from the Regulation and the Amendment Act.

It should be noted that under section 2B(1A) of the LBATA, it is mandatory for Labuan entities to comply with the new substance requirement as specified in the Regulation. If a Labuan entity fails to comply with the Regulation, it will result in an increase of the tax rate to 24%. Nonetheless, compliance will likely be difficult for a Labuan international commodity trading company due to its removal from the list of ‘Labuan entities’ in the Regulation. In this regard:

  • The Labuan Financial Service Authority has issued a letter dated 9 February 2021 wherein it assured that ‘Labuan international commodity trading companies’ will be regulated under a separate gazette order.

 

What are the updates brought about by the introduction of the Amendment Act and the Regulation?

Spurred on by the introduction of the base erosion and profit shifting action plan whose purpose is to encourage the usage of the best standards for taxation matters, the government of Malaysia brought about the following key changes to the Labuan regime:

  1. The Amendment Act removed the restriction on the non-usage of Malaysian Ringgit and the restriction on dealing with Malaysian residents (amendment to section 2);
  2. The introduction of new substance requirements (employee requirement and economic requirement) for Labuan entities in accordance with the table provided under the Regulation (under section 2B(1)(b));
  3. The exclusion of income derived from royalty or intellectual property right (if received as consideration for the commercial exploitation of that right) from the chargeable profits. Such income will now be taxed under the Income Tax Act 1967 (amendment to section 4); and
  4. The removal of the option to pay a fixed tax rate of RM20,000 for Labuan entities carrying on Labuan trading activity (deletion of section 7).
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