Impact of New Labuan Tax Changes

Impact of New Labuan Tax Changes

The Labuan tax system experienced some important changes for The Budget 2019 announcement by the Minister of Finance on 2 November 2018. These changes are in sync with Malaysia’s commitments as a member of the Inclusive Framework on Base Erosion and Profit Shifting (BEPS) to cater to tax evasion and detrimental tax practices, containing the increase of substantial activities requirements in Labuan.

  1. Substance Requirements

Under the revised Section 2B(1)(b) of the Labuan Business Activity Tax Act, 1990 (LBATA), a Labuan entity must for the intent of the Labuan business activity have a sufficient number of full-time employees and a suitable amount of annual operating expenditure in Labuan, as mentioned under the Labuan Business Activity Tax (Requirements for Labuan Business Activity) Regulations 2018 (Substance Requirements) that took effect from 1 January 2019.

For instance, a Labuan “trading company” is needed to have a minimum of two Full Time Employees (FTEs) in Labuan and an annual operating expenditure in Labuan of a minimum of MYR 50,000, while other Labuan “financial business license company” is needed to meet the FTEs and an annual operating expenditure in Labuan based on the latest requirements by relevant authorities.

Under the recently enacted Labuan Business Activity Tax (Amendment) Act 2020 (“LBATA 2020 Amendment”), where Substance Requirements are not fulfilled with, effective from year of assessment 2020, the Labuan entity will be taxed at the rate of 24% on its net profits for that year of assessment. Hence, the outcome of not matching the Substance Requirements under LBATA 2020 Amendment is that capital gains and foreign source income would also be taxed at the rate of 24%.

  1. Elimination of the Flat Tax Rate

With the deletion of Section 7 of the LBATA effective from 1 January 2019, a Labuan taxpayer can no longer elect to pay tax at the fixed amount of MYR 20,000 for each year of assessment. Therefore, tax will be charged at the rate of 3% on net profits from its Labuan business activity for the basis period for the year of assessment.

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  1. Income from Intellectual Property Rights

Under the amendment to Section 4(4) of the LBATA, income gained from royalty or intellectual property rights is now subject to tax under the Malaysian Income Tax Act, 1967 (ITA) instead under the LBATA. The general income tax rate for organisations (non-SMEs) in Malaysia under the ITA is 24%.

  1. Resident Status of a Labuan Entity

Before the LBATA 2020 Amendment, there was no provision in the LBATA which made citation to the network of double taxation. Under the new Section 3B of the LBATA 2020 Amendment, for the intent of the double taxation agreements under Section 132 of the ITA :-

          a) A Labuan entity exercising on a business is resident in Malaysia for a YA (Year Ago) if at any time in the basis year the management and control of its business is carried in Malaysia; and

         b) Any other Labuan entity is resident in Malaysia for a YA if at any time during that basis year the management and regulation of its affairs are exercised in Malaysia by its directors, partners, trustees or other regulating authority.

  1. Restriction of Tax Deductions for Payments Made to a Labuan Company by Malaysian Taxpayer

Before this amendment, a Malaysian taxpayer could request an entire deduction for payments done to a Labuan entity under Section 33 of the ITA.

Although, because of the introduction of the new Section 39(1)(r) of the ITA, payments done to a Labuan company by a Malaysian taxpayer will be prohibited under Section 33 of the ITA unless otherwise appointed by the Ministry of Finance. Under the Income Tax (Deductions Not Allowed for Payments Made to Labuan Company by Resident Rules 2018 – “Disallowance Rules”), the appointed amounts disallowed from deduction for the following kinds of payments done to a Labuan company are as follows :-

Types of PaymentAmount Not Allowed for Deduction

 

Interest Payment33%

 

Lease Rental33%

 

Other Payments97%

 

Other Significant Changes :-

Tax Treatment

a) Tax Rate

The tax rate applicable to a Labuan entity is 3% on the liable income from Labuan business activities only. This signifies that the income from the Labuan non-trading activities (i.e. the holding of investments in securities, stocks, shares, loans, deposits or other properties) of a Labuan entity is not subject any tax at all – ZERO tax! Find out How to Set Up an Investment Holding Company here!

b) Net Profit per Audited Accounts for Labuan Trading Activities

Tax is liable only on the net profits as demonstrated in the audited accounts in regard of Labuan business activities – i.e. banking, insurance, trading, management, licensing, shipping operations and any other activity (apart from the holding of investments in securities, stocks, shares, loans, deposits or other properties).

An Interesting Read: Labuan Tax Structures

Exemptions

a) No Indirect Taxes

Labuan receives free-port status. Therefore, indirect taxes are not pertinent to Labuan entities situated in Labuan. Hence, Labuan entities are released from sales tax and service tax.

b) Stamp Duty

Stamp duty is exempted on all instruments performed by a Labuan entity in relationship with its Labuan business activity.

c) Exchange Control

Labuan entities are also not subject to exchange control restrictions.

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Payments by Labuan Entities

The following exemptions (ZERO tax) are accessible to recipients of income from Labuan entities :-

a) Dividends Attained by a Labuan Company

Dividends obtained from a Labuan company which are paid, credited or distributed out of income derived from a Labuan business activity including income exempted from tax

b) Distributions Attained from a Labuan Trust by the Beneficiaries

Interest obtained from a Labuan company by a resident person (other than a person licensed to carry on a business under the Banking and Financial Institutions Act 1989, Islamic Banking Act 1983, Insurance Act 1996 or Takaful Act 1984)

c) Withholding Tax

Furthermore, the following payments made by Labuan entities to non-residents are exempted in the hands of non-resident recipients, and therefore are not subject to withholding provisions :-

  • Royalties
  • Interest
  • Technical services, advice or assistance specified in section 4A(i) and (ii) of the Income Tax Act, and
  • Other income

Labuan – An OECD Whitelist Jurisdiction

The island of Labuan was identified to be a free-trade zone and financial centre in 1990. Its reduced taxes, Double Taxation Agreements strong legal system, Shariah-compliant financial products and services, and compliance to international ideal practices and guidelines, makes the Labuan International Business and Financial Centre (Labuan IBFC) an ideal yet lucrative investment destination.

The beneficial tax regime signifies that ZERO Tax is payable on non-trading activities and Labuan business activities are taxed at 3% of net audited profit.

Being one of the federal territories of Malaysia, Labuan provides excellent and internationally accepted laws and structures for investment holding, funds, leasing, shipping, insurance, banking, trading and wealth management activities. To benefit from such opportunities, contact our QX Trust team of consultants at +60 3 9212 6940 or consultant@qx-trust.com for a free consultation.