Authored by Nicholas Teh, Tiffany Ding & Wendy Tan
Labuan is a federal territory of Malaysia comprising of seven small islands off the coast of Sabah, East Malaysia. It is a major international business and financial centre (“IBFC”) governed by the Labuan Financial Services Authority (“LFSA”) which acts as the regulatory, supervisory and enforcement authoritative body. In order to make Labuan an attractive destination for offshore company formation, several amendments and new regulations have been introduced into the Labuan tax regime.
Labuan Business Activities
Section 2(1) Labuan Business Activity Tax Act 1990 (“LBATA”) defined Labuan business activity as a Labuan trading or non-trading activity carried on, in, from or through Labuan. At the outset, it is relevant to understand the definitions of Labuan trading activity and Labuan non-trading activity. Labuan trading activity includes banking, insurance, trading, management, licensing, shipping operations or any other activity which is not a Labuan non-trading activity. On the other hand, Labuan non-trading activity means an act 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.
The Labuan Tax Structure
The general overview of the Labuan Tax Structure is as follows :-
Mandatory Fulfilment of Economic Substance Requirements
Generally, all Labuan entities carrying out Labuan business activity is subject to a tax rate of 0% to 3% on its chargeable profits as reflected in their audited accounts. In order to enjoy the said preferential tax rate, the Labuan entity has to be one of the entities specified in the Schedule pursuant to Section 2B(1) of the LBATA and it has to fulfil the economic substance requirements as set out in the Labuan Business Activity Tax (Requirement for Labuan Business Activity) Regulations 2018. Failure to meet the Substance Requirements would result in the Labuan entity carrying on a Labuan business activity to be subject to tax under the LBATA at the rate of 24% of its net profits for that year of assessment.
Prior to the recent amendments brought about by the Labuan Business Activity Tax (Amendment) Act 2020 (“LBATA Amendment 2020”) and Labuan Business Activity Tax Act (Requirements for Labuan Business Activity) 2018 (Amendment) Regulations 2020 (“LBATA Regulations 2020”), the LFSA has added the category of ‘Other trading entity’ which includes Labuan entities carrying out administrative, accounting and legal services including backroom processing, payroll services, talent management, agency services, insolvency related services and management services. However, following the said recent amendments, the Inland Revenue Board (“IRB”), by way of a letter dated 5.2.2021 addressed to the Chairman of Association of Labuan Trust Companies Act ("ALTC"), interpreted that the said category had since been removed and the other trading activities are no longer included in the meaning of Labuan Entity under subsection 2B(1) of the LBATA.
This interpretation has adversely affected many Labuan entities which are carrying out “Other trading activity”, such that they are to be taxed under the Income Tax Act 1967 (“ITA”) and that all resubmission for tax return has to be done retrospectively from 1.1.2019 under the ITA. The said Labuan entities which are affected would also be required to cover the differences between the tax rates for the two (2) financial years assessment. Such interpretation is deemed to be unfair to companies that have elected to incorporate their business or entity pursuant to Section 2B(1)(a) of the LBATA to now be subjected to the ITA when they did not elect to do so under Section 3A of the LBATA.
Given the said letter from the IRB, does this mean that many of the Labuan entities would now have to review their existing business structure in order to ensure that they are complying with the requirements following the interpretation by the IRB so as to enjoy the preferential tax rate in Labuan?
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