In November last year, the new Pakatan Harapan government announced its proposed budget for 2019. The measures suggested by the coalition government in their first budget to continue to enhance the competitiveness of Labuan include the removal of trade restrictions in Ringgit and transaction restrictions between Malaysian residents and Labuan, and maintaining the tax rate at 3 percent. This means that RM20,000 tax ceiling as stipulated in Labuan Business Activity Tax will no longer be valid. Furthermore, it was announced that Malaysian residents or companies transacting with a company in Labuan is eligible for expenditure tax deduction subject to a limit of 3 percent of the permissible expenditure.
Allowable Expenditure – What Is It?
A Labuan company is taxed on the basis of audited net profit. In the case of a Malaysian company, non-allowable expenses such as those associated with entertainment, travel, and those that are not liked exclusively or wholly with trade should be added back to the audited net profit in order to determine the taxable profit. The Inland Revenue Board of Malaysia allows companies to deduct a percentage of such expenses (for example, 50 percent) from the taxable net profit, but definitely not 100 percent.
As proposed in the 2019 budget, only 3 percent of the allowable expenditure will be considered for tax deductions in the case of a Malaysian company. As such, the Malaysian companies that involve in business transactions with the following Labuan entities have strongly objected to this proposal in the budget:
- Labuan Leasing Companies,
- Labuan Banks including Labuan Investment Banks,
- Labuan Insurance Companies,
- Labuan Trading Companies, and
- Labuan Trust Companies.
The impact of the proposed amendment in the 2019 budget is that it discourages Malaysian companies from carrying out businesses with Labuan companies. Here is a case study to substantiate the same.
Labuan Leasing Company – A Case Study
Let us assume that a Malaysian company leases a tug boat from a Labuan entity and the lease rental is USD 1,000,000 per annum. For the Malaysian company’s tax computation purpose, only 3 percent or USD 30,000 can be deducted from the taxable income. This means that the company will have to pay tax on USD 970,000. If the Malaysian company’s taxable income falls within the 20 percent tax bracket, the additional tax payable by the company is 20 percent of USD 970,000 and it works out to USD 194,000.
Now, if the Malaysian company leases a boat from a company in Singapore for the same lease rental, the withholding tax payable by the company is 10 percent and it works out to USD 100,000. This means that a Malaysian company leasing a boat from a company in Singapore rather than from a Labuan entity stands to enjoy a tax savings of USD 94,000.
In conclusion, if the Government of Malaysia decides to go ahead with its proposed 2019 budget, many of the existing Labuan companies will be forced to change their current structure, give up their licenses, close operations in Labuan, or look for alternate offshore jurisdictions such as Hong Kong or Singapore.